Uncertainty, firm entry, and investment dynamics
| Published date | 01 November 2021 |
| Author | Stelios Giannoulakis |
| Date | 01 November 2021 |
| DOI | http://doi.org/10.1111/sjpe.12293 |
Scott J Polit Econ . 2021;68:623–642. wileyonlinelibrary.com/journal/sjpe
|
623
© 2021 Scottish Ec onomic Society
Accepted: 6 July 2 021
DOI: 10 .1111/sjpe.1 2293
ORIGINAL ARTICLE
Uncertainty, firm entry, and investment dynamics
Stelios Giannoulakis
Department of Economics, Athens
Universit y of Economics and Busi ness,
Athens, Greece
Correspondence
Stelios Giannoulakis, Department of
Economics, At hens Universit y of Economics
and Business , 76 Patission Street, At hens
10434, Greece.
Email: stgiannoulak@aueb.gr
Abstract
Previous macro- and micro- level evidence indicate that
fluctuations in id iosyncratic unce rtainty have an im portant
effect on invest ment, both direc tly and indirec tly through
financial market fri ctions. The obje ctive of this paper was
to explore, beyond the t wo traditional a nd complementar y
channels, a new one: f irm entry. By utilizing a novel and large
dataset on Greek f irms covering the entire e conomy over
the period 200 0– 2014 and employing a panel- VAR method-
ology, we examine and evalua te the impact of shocks to the
number of star tups, idiosyncr atic uncertai nty, and financial
conditions on the inves tment growth at the in dustry level.
Our findings ca n be summarized as follows. First, a sh ock to
the number of new firm s has significant ef fects on invest-
ment that persist fo r many years. Second, a lthough all the
three variables a re important dr ivers of investment grow th
dynamics, uncertainty has the largest impact (explaining
about the 15% of the variabil ity of investment growth), firm
creation follows (it exp lains about the 7%), whil e financial
conditions have the small est direct eff ect (explaining the
3.5%). Finally, we demonstr ate that firm entr y constitutes
an important propagation mechanism for the transmission
of uncertaint y shocks in the investment grow th trajectories.
KEYWORDS
economic uncertainty, financial frictions, firm entry, Greek crisis,
idiosyncratic volatility, investment dynamics
624
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GIANNOULAKIS
1 | INTRODUCTION
The impact of mic roeconomic vol atility, often inter preted as a measu re of economic unce rtainty or r isk, on
the macroecon omy has been consid ered as a well- documented fa ct in the litera ture of macroecon omics (De
Vierman & Levin , 2018). The relevant literature has sh own that the idiosyncratic vola tility can directly aff ect
investment and o utput outcome s in the presence of si gnificant adj ustment cost s (see for insta nce Abel &
Eberly, 1994; Bachmann & Bayer, 2013; Ber nanke, 1983; Bloom, 2014; Stores letten et al., 20 04). The Great
Recession gave a fur ther boost in this liter ature (Chen & Funke, 2010). The literat ure pointed to financial mar-
ket frictions as an additional channel through which changes in microeconomic volatility can affect business
cycle fluctu ations (see Arel lano et al., 2019; Chris tiano et al., 2014) and inves tment dynami cs in particu lar
(Gilchrist et al ., 2014).
Given these t wo complementary channe ls, the direct and the indir ect through financial fr ictions, of how un-
certaint y fluctuations can affec t investment trajector ies, this paper seeks to exam ine a new channel: firm entr y.
We address two cent ral question s. First, do es firm entr y affect inves tment dynami cs? And second, is t here a
linkage betwe en firm entr y and economic un certaint y and, if yes, how do es this linkage af fect the inves tment
behavior?
Firm entry c an be considered a s a form of irreversi ble investment (G ourio et al., 2016), since e ntrants bea r
considerable u pfront costs to i nitiate a business e xpecting f uture profits . Therefore, we ex pect that the s ame
factors tha t influence invest ment— in our c ase, credit constraints an d uncertainty— natur ally react on f irm entry
(Clementi & Palaz zo, 2016; Luttmer, 2012). Mor eover, Sedlacek (2020) sh owed that for the US e conomy the
large and persi stent decline in n ew business form ation during the 2 007– 2009 contract ion is responsib le for its
slow recovery. Ther efore, a natural question th at arises here is whether fir m entry shocks can lead to p ersistent
investment dynamics.
The role of entr y in uncertainty is ve ry interesting and h as not been examined in th e investment literatur e yet.
Although unce rtainty (firm idio syncratic volatilit y) has a very import ant impact on investme nt, it is measured only
for incumbent s (it is determined by the produ ction decision), while star tups are ignored. However, firm e ntry, as
a form of irreversi ble investment, could be af fected by uncertai nty. For instance, uncert ainty for incumbents c an
either signal bu siness opportuniti es for entrants or bad mar ket conditions discouragi ng potential entrants . To the
best of our knowl edge, this is the first stud y examining the interplay bet ween uncertainty (prod uction decision)
and firm entr y (entry decision) and how th is interlinkage contribu tes to investment dynamic s.
We answer our two res earch questions by focusing on G reece. Having microeconomic d ata at both the firm
level and the indu stry level for the tim e period 2000– 2014 and using a pane l- VAR methodolog y, we examine how
shocks in econo mic uncertainty, firm entr y, and credit conditions affec t investment growth rates . Our firm- level
data are propri etary and obtai ned from ICAP Grou p, SA, a private rese arch company that collec ts detailed bal ance
sheet and incom e statement information for SA an d Ltd companies in Greece. Using the se data, we construct a
measure for micro economic volati lity (firm- level volatilit y of sales growth) by following the met hodology of De
Vierman and Le vin (2018), adapted for t he case of Greece a ccording to Giann oulakis and Sake llaris (2020). We
employ financi al leverage and liquidity a s proxies for credit conditio ns. ICAP's informati on for firm entries comes
from administrative records.
Our results ar e summarized as follows. We find that a p ositive shock in firm entr y leads to a persistent stim-
ulation of investm ent activity. We also show that a positive s hock in economic uncertaint y and an adverse one
in credit condit ions have import ant adverse effects on inve stment. Thus, firm entr y along with uncertaint y and
financial cond itions constitute impo rtant direct chann els for investment dynam ics at the industry l evel. However,
uncertaint y has the largest impact (expl aining about th e 15% of the variabilit y of investment growth), firm cre-
ation follows (it ex plains about the 7%), while fin ancial conditions have the smalle st direct effect (explai ning the
3.5%). It is notabl e that although the impac t of shocks to uncert ainty and financial co nditions fades over time , the
effects of a s hock to firm creation persis t. Finally, we demonstrate tha t beyond its direct effec t, uncertainty has
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