Competition and the Real Effects of Uncertainty

83 Pages Posted: 22 Jun 2016

Date Written: January 22, 2016


This paper investigates the impact of uncertainty on firm-level capital investment and examines whether this effect depends on the degree of competition that firms face. I exploit a unique empirical setting to construct a time-varying uncertainty measure that is exogenous to economic conditions and firm behavior. I show that higher uncertainty results in a decrease in investment for firms in more concentrated industries. The effect is stronger for firms that face higher costs associated with reversing investments. This finding is in line with irreversible investment models that predict a negative relationship between uncertainty and investment. In contrast, firms in highly competitive industries increase investment in response to higher uncertainty, supporting the argument that competition can erode the option value of deferring investment. In that case, other industry and firm characteristics such as operational flexibility can result in increased investment in response to heightened uncertainty. I also find economically significant effects of uncertainty on other types of investment such as R&D spending, advertising and investment in human capital. Collectively, my results illustrate that the degree of competition plays an important role in the link between uncertainty and investment.

Keywords: Uncertainty, Investment, Competition, Real Options, Irreversibility

JEL Classification: G31, G32

Suggested Citation

Patnaik, Raja, Competition and the Real Effects of Uncertainty (January 22, 2016). Available at SSRN: or

Raja Patnaik (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

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