The Dynamic Effect of Uncertainty on Corporate Investment through Internal and External Financing

Using firm-level data on the Japanese manufacturing industry, this study identifies the causal effect of uncertainty on the dynamic relation between corporate investment and financing conditions. It demonstrates that the cautionary effect is increasingly dominant under high uncertainty irrespective of the type of corporate investment—capital investment and R&D—and that this result remains even in the weak instrument robust inference. Hence, the dominance of the cautionary effect over the financing constraint effect makes actual corporate investment decisions under high uncertainty indifferent to the firm’s financing conditions.