The Effects of Irreversibility and Uncertainty on Capital Accumulation

44 Pages Posted: 22 Jun 2000 Last revised: 27 Feb 2021

See all articles by Andrew B. Abel

Andrew B. Abel

University of Pennsylvania - Finance Department; National Bureau of Economic Research (NBER)

Janice C. Eberly

Northwestern University - Kellogg School of Management

Multiple version iconThere are 2 versions of this paper

Date Written: November 1995

Abstract

When investment decisions cannot be reversed and returns to capital are uncertain, the firm faces a higher user cost of capital than if it could reverse its decisions. This higher user cost tends to reduce the firm's capital stock. Opposing this effect is the irreversibility constraint itself: when the constraint binds, the firm would like to sell capital but cannot. This effect tends to increase the firm's capital stock. We show that a firm with irreversible investment may have a higher or a lower expected capital stock, even in the long run, compared to an otherwise identical firm with reversible investment. Furthermore, an increase in uncertainty can either increase or decrease the expected long-run capital stock under irreversibility relative to that under reversibility. However, changes in the expected growth rate of demand, the interest rate, the capital share in output, and the price elasticity of demand all have unambiguous effects.

Suggested Citation

Abel, Andrew B. and Eberly, Janice C., The Effects of Irreversibility and Uncertainty on Capital Accumulation (November 1995). NBER Working Paper No. w5363, Available at SSRN: https://ssrn.com/abstract=225426

Andrew B. Abel (Contact Author)

University of Pennsylvania - Finance Department ( email )

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Janice C. Eberly

Northwestern University - Kellogg School of Management ( email )

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