How investment irreversibility shapes firm responses to monetary policy: Evidence from a major earthquake

This study investigates the role of investment irreversibility in shaping firms’ heterogeneous investment responses to monetary policy shocks. We leverage the 2008 Wenchuan Earthquake as a natural experiment for investment irreversibility. Using a difference-in-differences approach, we demonstrate that the earthquake significantly heightened investment irreversibility among firms in disaster-affected regions. Our central finding, robust across baseline regressions and the exogenous shock setting, is that greater irreversibility consistently intensifies firms’ investment sensitivity to monetary policy. Mechanism analysis reveals this effect is asymmetric and driven by adjustment cost channel. Firms with high irreversibility display significantly greater sensitivity to contractionary shocks, reducing investment substantially, yet their responses to expansionary shocks are relatively subdued. This heightened sensitivity is particularly evident among firms more vulnerable to adjustment costs, such as those facing higher financial risks and exhibiting lower liquidity and profitability. By integrating investment irreversibility into monetary transmission mechanisms, our research enhances understanding of the heterogeneous responses of firms to monetary policy changes. These findings underscore the importance of incorporating firms’ investment characteristics into the design of effective monetary interventions, especially in disaster-affected contexts where irreversibility constraints are binding.