The Impact of Uncertainty Shocks on the Investment of Small and Large Firms : Micro Evidence and Macro Implications

This paper investigates how cross-sectional micro-uncertainty influences the investment of small and large firms and discusses the aggregate implications of the heterogeneity in their investment decisions. Empirically, we find that large firms show less investment decline in times of heightened uncertainty. We provide empirical evidence for the underlying driver of the observed size effect: the heterogeneous responses across firms are in fact the consequence of large firms operating in multiple markets rather than their size per se. To interpret these findings, we build a heterogeneous firm model with single- and multi-unit firms subject to (i) unit-level real frictions, i.e., fixed and convex investment adjustment costs and (ii) firm-level financial frictions, i.e., costly equity issuance. In the model with unit-level frictions, an increase in uncertainty lowers the investment of both single and multi-unit firms through a `wait-and-see' effect. For a multi-unit firm, on the other hand, firm-level financial frictions generate the interdependence of investment across units within a firm, i.e., a fall in investment in one unit enlarges internal funds and so relaxes the constraint on the amount a firm can invest in the other unit. Therefore, upon uncertainty shocks, multi-unit firms lower their investment by less than single-unit firms. This is because the `wait-and-see' effect is partially offset by the relaxation of financial constraints due to the availability of larger internal funds when investment in one unit decreases. To examine the aggregate implications due to the heterogeneity in firms' responses, we compare the benchmark economy to a counterfactual economy with only single-unit firms. The result shows that the contribution of multi-unit firms is sizable in alleviating the impact of uncertainty shocks on aggregate investment