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An Empirical Examination Of The Hangover Effect Of Irreversibility On Investment

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  • Hong Bo

Abstract

Irreversibility does not only raise the user cost of capital and discourage new investment but also hinders disinvestment because of the hangover effect. This paper derives a theoretical model that separates the impact of conventional convex adjustment costs from the impact of irreversibility, based on which we test the hangover effect of irreversibility by using a panel of Dutch listed firms during 1985–2000. We find that the sample firms cut both the capital stock and the inventory stock facing shocks to sales and cash flow, but they cut the inventory stock by a larger magnitude than they cut the capital stock. Given that fixed investment is more irreversible than inventory investment, the result suggests that the diminished impact of irreversibility provides the firm with more flexibility in responding to uncertainty, which lends support for the hangover effect of irreversibility on investment.

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  • Hong Bo, 2006. "An Empirical Examination Of The Hangover Effect Of Irreversibility On Investment," Scottish Journal of Political Economy, Scottish Economic Society, vol. 53(3), pages 358-376, July.
    • Handle: RePEc:bla:scotjp:v:53:y:2006:i:3:p:358-376
    DOI: 10.1111/j.1467-9485.2006.00384.x
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    Cited by:

    1. Babajide Fowowe, 2011. "Financial Sector Reforms And Private Investment In Sub-Saharan African Countries," Journal of Economic Development, Chung-Ang Unviersity, Department of Economics, vol. 36(3), pages 79-97, September.

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