Uncertainty, Capital Investment, and Risk Management

Forthcoming, Management Science

43 Pages Posted: 25 Aug 2013 Last revised: 3 Apr 2017

See all articles by Hitesh Doshi

Hitesh Doshi

University of Houston - C.T. Bauer College of Business

Praveen Kumar

University of Houston - Department of Finance

Vijay Yerramilli

University of Houston, C. T. Bauer College of Business

Date Written: March 31, 2017

Abstract

We use forward-looking and exogenous measures of output price uncertainty to examine the effect of price uncertainty on firm-level capital investment, risk management, and debt issuance. The effects of uncertainty vary significantly by firm size. When faced with high price uncertainty, large firms increase their hedging intensity but do not lower capital investment or debt issuance. In contrast, small firms do not adjust their hedging intensity but significantly lower capital expenditure and debt issuance even after controlling for investment demand. Moreover, the negative effect of uncertainty on capital investment is significantly weaker for firms that hedge their output price risk. Our analysis highlights that, in the presence of financial frictions, high price uncertainty has significant dampening effects on capital investment of small firms by exacerbating their financial constraints, and that this negative effect is amplified by firm-level constraints on ability to hedge risk exposures.

Keywords: Uncertainty; capital investment; hedging; real options; financial frictions

JEL Classification: G31, G32, D92, D81

Suggested Citation

Doshi, Hitesh and Kumar, Praveen and Yerramilli, Vijay, Uncertainty, Capital Investment, and Risk Management (March 31, 2017). Forthcoming, Management Science. Available at SSRN: https://ssrn.com/abstract=2315217 or http://dx.doi.org/10.2139/ssrn.2315217

Hitesh Doshi

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Praveen Kumar

University of Houston - Department of Finance ( email )

Houston, TX 77204
United States
713-743-4770 (Phone)
713-743-4789 (Fax)

Vijay Yerramilli (Contact Author)

University of Houston, C. T. Bauer College of Business ( email )

Houston, TX 77204
United States
713-743-2516 (Phone)

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