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Asset fixity and backward-bending investment demand functions

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  • Kropp, Jaclyn D.
  • Power, Gabriel J.

Abstract

We investigate irreversible investment behavior under uncertainty of payoffs using U.S. firm-level panel data. Specifically, we estimate the relationship between the firm’s investment to capital ratio and the interest rate, while controlling for investment opportunities, real option values, uncertainty, and profitability. The results indicate that the investment demand curve is a backward-bending function of the interest rate. That is, at low interest rates an increase in the interest rate leads to additional investment by increasing the cost of postponing investment. Interestingly, the backward-bending shape of investment demand does not hold for the sub-sample of agribusiness firms in our dataset, which are characterized by greater asset fixity. Lastly, firm investment behavior is consistent with the existence of real option values.

Suggested Citation

  • Kropp, Jaclyn D. & Power, Gabriel J., 2016. "Asset fixity and backward-bending investment demand functions," Research in International Business and Finance, Elsevier, vol. 38(C), pages 151-160.
    • Handle: RePEc:eee:riibaf:v:38:y:2016:i:c:p:151-160
    DOI: 10.1016/j.ribaf.2016.03.012
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    References listed on IDEAS

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    Cited by:

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    4. Gutiérrez, Óscar, 2020. "On the definition of the investment-uncertainty relationship," Journal of Economics and Business, Elsevier, vol. 112(C).

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    More about this item

    Keywords

    Investment demand; Irreversible investment; Real options; Asset fixity; Interest rate;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • Q13 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Agricultural Markets and Marketing; Cooperatives; Agribusiness

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