How economic depreciation shapes the relationship of uncertainty with investments’ size & timing

Nick Fijbo Dick Huberts; Rafael Rossi Silveira

doi:10.1016/j.ijpe.2023.108836

How economic depreciation shapes the relationship of uncertainty with investments’ size & timing

Nick Fijbo Dick Huberts^*, Rafael Rossi Silveira

^*Corresponding author for this work

The York Management School

Research output: Contribution to journal › Article › peer-review

Abstract

This paper identifies and analyzes the effects of the rate of economic depreciation of capital stock on a monopolist’s investment option and capacity decision in a dynamic and uncertain market environment, where continuous economic depreciation cannot be fully offset. We find that the firm’s capital stock is increasing in the rate of depreciation for low rates and decreasing for higher rates. Further, when considering the timing of investment, we show that the effect of uncertainty on investment is level-dependent on the rate of depreciation: only for sufficiently high rates of depreciation there is a positive relationship between capital investment and uncertainty, and the impact of uncertainty on the present value of the firm is mitigated. The fact that the impact of economic depreciation on the firm’s investment problem is level dependent demonstrates that its consideration by investors and managers is not trivial.

Original language	English
Article number	108836
Number of pages	16
Journal	International Journal of Production Economics
Volume	260
Early online date	28 Mar 2023
DOIs	https://doi.org/10.1016/j.ijpe.2023.108836
Publication status	Published - Jun 2023

Keywords

Economic depreciation
Capital investment
Investment under uncertainty
Monopoly

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10.1016/j.ijpe.2023.108836Licence: CC BY-NC-ND

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Cite this

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title = "How economic depreciation shapes the relationship of uncertainty with investments{\textquoteright} size & timing",

abstract = "This paper identifies and analyzes the effects of the rate of economic depreciation of capital stock on a monopolist{\textquoteright}s investment option and capacity decision in a dynamic and uncertain market environment, where continuous economic depreciation cannot be fully offset. We find that the firm{\textquoteright}s capital stock is increasing in the rate of depreciation for low rates and decreasing for higher rates. Further, when considering the timing of investment, we show that the effect of uncertainty on investment is level-dependent on the rate of depreciation: only for sufficiently high rates of depreciation there is a positive relationship between capital investment and uncertainty, and the impact of uncertainty on the present value of the firm is mitigated. The fact that the impact of economic depreciation on the firm{\textquoteright}s investment problem is level dependent demonstrates that its consideration by investors and managers is not trivial.",

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AB - This paper identifies and analyzes the effects of the rate of economic depreciation of capital stock on a monopolist’s investment option and capacity decision in a dynamic and uncertain market environment, where continuous economic depreciation cannot be fully offset. We find that the firm’s capital stock is increasing in the rate of depreciation for low rates and decreasing for higher rates. Further, when considering the timing of investment, we show that the effect of uncertainty on investment is level-dependent on the rate of depreciation: only for sufficiently high rates of depreciation there is a positive relationship between capital investment and uncertainty, and the impact of uncertainty on the present value of the firm is mitigated. The fact that the impact of economic depreciation on the firm’s investment problem is level dependent demonstrates that its consideration by investors and managers is not trivial.

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