Demand Volatility and Firms’ Investments in Operating Flexibility: Evidence from Planned Power Plants

Fisher College of Business Working Paper No. 2019-03-026

Charles A. Dice Center Working Paper No. 2019-26

70 Pages Posted: 4 Nov 2019 Last revised: 6 Jun 2022

See all articles by Chen Lin

Chen Lin

The University of Hong Kong - Faculty of Business and Economics

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2, 2022

Abstract

How does demand volatility affect firms’ investment decisions? We consider this issue from the perspective of electricity-producing firms. Their most important investment decisions concern their new power plants, which vary substantially in their flexibility to adjust their output to changing market conditions. Using an international sample of planned power plants, we find that more volatile demand causes firms to invest more in flexible plants and less in nonflexible plants, while the overall investment level remains unchanged. This effect, which is robust to a number of alternative specifications, including a weather-based IV for demand volatility, is consistent with models in which asset flexibility is an important attribute of investments when demand is volatile.

Keywords: Demand volatility, firm investment, operating flexibility, operating leverage, power plants

JEL Classification: G30, G31

Suggested Citation

Lin, Chen and Schmid, Thomas and Weisbach, Michael S., Demand Volatility and Firms’ Investments in Operating Flexibility: Evidence from Planned Power Plants (June 2, 2022). Fisher College of Business Working Paper No. 2019-03-026, Charles A. Dice Center Working Paper No. 2019-26, Available at SSRN: https://ssrn.com/abstract=3478625 or http://dx.doi.org/10.2139/ssrn.3478625

Chen Lin (Contact Author)

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Thomas Schmid

The University of Hong Kong - Faculty of Business and Economics ( email )

Pokfulam Road
Hong Kong
China

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI) ( email )

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1000 Brussels
Belgium

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