The Impact of Ambiguity on Managerial Investment and Cash Holdings

29 Pages Posted: 20 Oct 2014

See all articles by Monica Neamtiu

Monica Neamtiu

City University of New York - Stan Ross Department of Accountancy

Nemit Shroff

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Hal D. White

University of Notre Dame

Christopher D. Williams

University of Michigan, Stephen M. Ross School of Business

Date Written: September/October 2014

Abstract

Standard finance theory suggests that managers invest in projects that, in expectation, produce returns that justify the use of capital. An underlying assumption is that managers have the information necessary to understand the distributional properties of the pay‐offs underlying the decision. This paper examines firm investment behavior when managers are likely to find it more challenging to develop expectations of pay‐offs, namely during periods of increased macroeconomic ambiguity. In particular, we examine how macroeconomic ambiguity – proxied by the variance premium (Drechsler, [Drechsler, I., 2010]) and the dispersion in forecasts of corporate profits from the Survey of Professional Forecasters (Anderson et al., [Anderson, E. W., 2009]) – impacts managerial capital investment and cash holdings. Consistent with ambiguity theory, we find that macroeconomic ambiguity is negatively associated with capital investment and positively associated with cash holdings. These results are robust to alternative explanations related to risk, investor sentiment and economic conditions. Moreover, consistent with recent theoretical real options literature, we find that ambiguity reduces the value of investment opportunities, while risk increases the value of such opportunities. Overall, these findings provide initial empirical evidence on the economic distinction between ambiguity and risk with respect to managerial investment and cash holdings.

Keywords: ambiguity, risk, investment, cash holdings

Suggested Citation

Neamtiu, Monica and Shroff, Nemit and White, Hal D. and Williams, Christopher D., The Impact of Ambiguity on Managerial Investment and Cash Holdings (September/October 2014). Journal of Business Finance & Accounting, Vol. 41, Issue 7-8, pp. 1071-1099, 2014, Available at SSRN: https://ssrn.com/abstract=2511993 or http://dx.doi.org/10.1111/jbfa.12079

Monica Neamtiu (Contact Author)

City University of New York - Stan Ross Department of Accountancy ( email )

One Bernard Baruch Way, Box B12-225
New York, NY 10010
United States

Nemit Shroff

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main St.
E62-679
Cambridge, MA MA 02142
United States
6173240805 (Phone)

HOME PAGE: http://mitsloan.mit.edu/faculty/detail.php?in_spseqno=51407&co_list=F

Hal D. White

University of Notre Dame ( email )

389C Mendoza College of Business
University of Notre Dame
Notre Dame, IN 46556
United States
574-361-3809 (Phone)

Christopher D. Williams

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States
(734)647-2842 (Phone)

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