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Uncertainty and the trade-off between scale and flexibility in investment

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  • Guthrie, Graeme

Abstract

This paper analyzes the behavior of a firm that chooses both the scale and timing of its investment. Sensitivity analysis shows that greater demand volatility is associated with the firm investing in larger increments, less frequently. This is in contrast to the conventional wisdom, which is that greater volatility leads to investment in smaller increments, more frequently. Overall, the reduced frequency dominates the greater scale, so that the long-run average rate of investment is a decreasing function of demand volatility. The timing and scale of investment are most sensitive to volatility when there are substantial investment economies of scale.

Suggested Citation

  • Guthrie, Graeme, 2012. "Uncertainty and the trade-off between scale and flexibility in investment," Journal of Economic Dynamics and Control, Elsevier, vol. 36(11), pages 1718-1728.
  • Handle: RePEc:eee:dyncon:v:36:y:2012:i:11:p:1718-1728 DOI: 10.1016/j.jedc.2012.04.008
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    References listed on IDEAS

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    Cited by:

    1. Kuno J.M. Huisman & Peter M. Kort, 2015. "Strategic capacity investment under uncertainty," RAND Journal of Economics, RAND Corporation, vol. 46(2), pages 376-408, June.
    2. Catherine Mathieu & Henri Sterdyniak, 2015. "What future for taxation in the EU?," Revue de l'OFCE, Presses de Sciences-Po, vol. 0(5), pages 5-13.
    3. Guthrie, Graeme, 2013. "A value premium without operating leverage," Finance Research Letters, Elsevier, vol. 10(1), pages 1-11.
    4. Flor, Christian Riis & Hesel, Søren, 2015. "Uncertain dynamics, correlation effects, and robust investment decisions," Journal of Economic Dynamics and Control, Elsevier, vol. 51(C), pages 278-298.

    More about this item

    Keywords

    Investment; Uncertainty; Real options; Economies of scale;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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