Investment and Demand Uncertainty: An Investigation with a Panel of Italian Firms

In the last fifteen years the debate about the investment-uncertainty relationship has flourished. From a theoretical point of view, uncertainty over the demand for a firm’s product may have unclear effects on investments, as it depends on a number of factors (such as the production technology and the degree of competition in the product market). Even assuming risk neutrality, the sign and the intensity of the investment-uncertainty relationship cannot be settled on purely theoretical grounds but need an empirical investigation. The aim of this paper is to extend the findings of the empirical literature by using a panel of Italian firms over a fairly long period of time (1996-2004), covering a complete business cycle. The availability of a panel of survey data about companies’ investment plans, expected future sales and demand uncertainty allows us to account for unobservable individual firm differences and for macroeconomic shocks, and to avoid the use of proxies based on assumptions at least quite restrictive. A key finding from our analysis is the increasing weakness over time of the link between investment plans and uncertainty. In explaining this fact, the results of the paper emphasise the influence on the investment-uncertainty relationship of the increase in the competition faced by Italian firms in the period under scrutiny. If our empirical analyses had been conducted with realised, instead of planned, data about the variables of interest, previous findings at best would have weaken, making evident that data of survey’s questionnaires are a key ingredient for appropriately modelling companies’ behaviour.