Uncertainty and investment: Evidence from Korean manufacturing firms

This paper examines empirically the effect of uncertainty on fixed investment based on a panel data set of Korean manufacturing firms over the period 1985–2002 using the first-differenced GMM estimation provided by Arellano and Bond (1991). The uncertainty measures, represented by the standard deviation of the unpredictable part of real sales or operating income, are constructed by employing second order autoregressive model of real sales growth rate or operating income per unit of sales. This paper finds that both demand uncertainty and profit uncertainty depress investment in Korean firms significantly. In addition, the investment is more sensitive to demand uncertainty for material industry group than for machine industry group. However, the influence of market power on the relationship between investment and uncertainty is ambiguous. Furthermore, using firm size as well as the belonging to chaebol firms or not as proxies for external capital market access, the quantitative negative impact of profit uncertainty is greater in large or chaebol firms, which is inconsistent with theoretical and empirical literature.;Finally, this paper finds that the top-five chaebol firms with higher expectation of government loss-protection invest more aggressively than independent firms as profit uncertainty increases. This result is consistent with the theoretical literature which predicts the role of a firm's risk attitude in altering the sign of the effect of uncertainty on investment.