Economic policy uncertainty and firm investment: evidence from the U.S. market

ABSTRACT

This paper examines the impact of economic policy uncertainty on firm-level capital investment, by not only delving into the long-term investment-uncertainty relation like previous studies, but also analyzing the short-term investment-uncertainty relation for the U.S. market. The empirical investigations show that firms decrease short-term, long-term, and total firm investments when encountering higher economic policy uncertainties. The research also explores the non-linear investment-uncertainty relation based on various theories. Our findings present a U-shaped relationship between short-term, long-term, and total investments and uncertainties. Policy implications are provided from our empirical results.

KEYWORDS:

• Firm investment
• uncertainty
• investment decision
• Tobin’s q
• bankruptcy risk
• market risk

JEL CLASSIFICATION:

• C23
• E22
• E66
• G32

Acknowledgments

The authors are grateful to the comments by the Editor and the anonymous referees on our paper. Chien-Chiang Lee is also thankful to the Ministry of Science and Technology of Taiwan for financial support through Grant MOST 104-2628-H-110-001.

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ The types of firm investment we test include short-term and long-term investments separately.

² As described in Compustat, the items include: i) accrued interest included with short-term investments by the company; ii) cash in escrow; iii) cash segregated under federal and other regulations; iv) certificates of deposit included in short-term investments by the company; v) certificates of deposit reported as a separate item in current assets; vi) commercial paper; vii) gas transmission companies’ special deposits; viii) good faith and clearing house deposits for brokerage firms; ix) government and other marketable securities, including stocks and bonds, listed as short-term investments; x) margin deposits on commodity futures contracts; xi) marketable securities; xii) money market funds; xiii) real estate investment trusts’ shares of beneficial interest; xiv) repurchase agreements (when shown as current assets); xv) restricted cash (when shown as a current asset); xvi) time deposits and time certificates of deposit (savings accounts when shown as current assets); and xvii) treasury bills – listed as short-term investments. On the other hand, it excludes the following: i) accrued interest not included in short-term investments by the company (included in Receivables – Other Current); ii) bullion, bullion in transit, and uranium in transit, among others (included in Inventories – Total); iii) cash and demand deposits (included in Cash and Short-Term Investments); iv) certificates of deposit included in cash by the company (included in Cash and Short-Term Investments); v) commercial paper issued by unconsolidated subsidiaries to the parent company (included in Receivables – Other Current); vi) demand certificates of deposit (included in Cash and Short-Term Investments); vii) money due from sale of debentures (included in Receivables – Other Current); and viii) short-term investments in equities (included in Current Assets – Other).

³ Figure 1’s data are from Baker, Bloom, and Davis (2013), and the annual data are the average of the monthly data.

⁴ CAPM originated from the idea of Markowitz’s (1952) portfolio allocation and was introduced by Treynor (1961, 1962), Sharpe (1964), Lintner (1965), and Mossin (1966).

⁵ To save space, readers can refer to Altman (1968) about the related factors. Note that we follow his specified weights when estimating a firm’s bankruptcy.

⁶ Equation (3) is the initial model, and there are several extended models, such as the three-factor model developed by Fama and French (1993). Herein, we consider only the original CAPM approach for estimating firms’ systematic risks.

Additional information

Funding

This work was supported by the Ministry of Science and Technology, Taiwan [MOST 104-2628-H-110-001].