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 idiosyncratic uncertainty have an important
effect on investment, both directly and indirectly through
financial market frictions. The objective of this paper was
to explore, beyond the two traditional and complementary
channels, a new one: f irm entry. By utilizing a novel and large
dataset on Greek firms covering the entire economy 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 startups, idiosyncratic uncertainty, and financial
conditions on the investment growth at the industry level.
Our findings ca n be summarized as follows. First, a sh ock to
the number of new firms has significant effects on invest-
ment that persist for many years. Second, although all the
three variables are important drivers 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 explains about the 7%), while financial
conditions have the smallest direct effect (explaining the
3.5%). Finally, we demonstrate that firm entry 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
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GIANNOULAKIS
1 | INTRODUCTION
The impact of microeconomic volatility, often interpreted as a measure of economic uncertainty or risk, on
the macroeconomy has been considered as a well- documented fact in the literature of macroeconomics (De
Vierman & Levin , 2018). The relevant literature has sh own that the idiosyncratic vola tility can directly aff ect
investment and output outcomes in the presence of significant adjustment costs (see for instance Abel &
Eberly, 1994; Bachmann & Bayer, 2013; Bernanke, 1983; Bloom, 2014; Storesletten 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 fluctuations (see Arellano et al., 2019; Christiano et al., 2014) and investment dynamics in particular
(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 central questions. First, does firm entry affect investment dynamics? And second, is there a
linkage between firm entry and economic uncertainty and, if yes, how does this linkage affect the investment
behavior?
Firm entry can be considered as a form of irreversible investment (Gourio et al., 2016), since entrants bear
considerable upfront costs to initiate a business expecting future profits. Therefore, we expect that the same
factors that influence invest ment— in our c ase, credit constraints an d uncertainty— naturally react on firm entry
(Clementi & Palazzo, 2016; Luttmer, 2012). Moreover, Sedlacek (2020) showed that for the US economy the
large and persistent decline in new business formation during the 2007– 2009 contraction is responsible 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 microeconomic volatility (firm- level volatilit y of sales growth) by following the met hodology of De
Vierman and Levin (2018), adapted for the case of Greece according to Giannoulakis and Sakellaris (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 conditions 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 (explaining about the 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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