Smietanka, Pawel
(2016)
Essays on macroeconomic uncertainty.
PhD thesis, University of Nottingham.
Abstract
Recent data shows that more than £440 billion in cash has been piling up in the accounts of UK companies. At the same time, the investment outlays and corporate payouts have reached a 60-year low. What makes firms hold such enormous cash stocks instead of spending them on investment or returning them to shareholders? To what extent has the rising degree of uncertainty about macroeconomic conditions affected companies’ decisions?
In this thesis we try to address these questions and, controlling for cyclical changes and financial factors, quantify the extent to which macroeconomic uncertainty has affected investments, cash holdings and equity payouts of UK companies.
In the first substantive chapter we describe how information about macroeconomic uncertainty can be obtained from surveys of professional forecasters by applying a method initially proposed by Lucas (1972). We construct a theoretical model in which professional forecasters combine predictions based on public information with private beliefs which are defined as predictions based solely on private information sets. In the model, the combination of predictions produced on the basis of public and private information sets leads to a combined forecast which is reported by forecasters in their regular statements. We extract private beliefs from reported forecasts and then use them to construct our measure of macroeconomic uncertainty. The use of predictions based on private knowledge instead of reported forecasts makes our measure of macroeconomic uncertainty distinct from other uncertainty proxies and highlights the important role of beliefs as the driving force of uncertainty. Based on the measure constructed here we conclude that macroeconomic uncertainty increases either when the overall volatility of the underlying economic processes increases or when economic conditions are perceived as more changeable. We then take the model to the data using outcomes of surveys of economic forecasters and compute a measure of macroeconomic uncertainty for the UK and the US. The results point to an interesting phenomenon. In both countries the most variation in macroeconomic uncertainty comes from changes in the perceived volatility, and not from changes in the volatility of underlying economic processes. Moreover, a comparison of our measure of macroeconomic uncertainty with other uncertainty proxies reveals that in the US our uncertainty measure is most similar to an uncertainty proxy based on disagreement among forecasters, while in the UK it is most similar to an uncertainty proxy based on average variance reported by professional forecasters. Furthermore, it appears that the period of elevated uncertainty in the UK was more prolonged than it has been believed so far.
In the second substantive chapter we examine the effects of uncertainty on corporate investments of a large panel of UK companies between 1998–2012 using the measure described earlier. Our regression equation is based on an extended version of a Tobin’s Q model and is estimated by the system GMM estimator. Apart from including the value of Tobin’s Q, which captures the ratio of the market value of capital to its book value, we also control for cash flow ratios, sales dynamic, individual uncertainty, business cycle and macroeconomic uncertainty. Our hypothesis is that macroeconomic uncertainty, defined as the expected volatility of the purely unforecastable component of the GDP growth rate conditional on information available at time t, negatively affects corporate investment ratios. We find indeed that a surge in macroeconomic uncertainty measured in this way is linked to a significant fall in investment ratios even after controlling for cyclical changes and a range of other factors. We also show that the effect of macroeconomic uncertainty on corporate investment is mainly driven by companies that are averagely financially constrained. These results are consistent with theories suggesting that the asymmetry of information is an important channel in the investment-uncertainty relationship and validate our measure of uncertainty.
In the third substantive chapter we analyse the effects of changes in the degree of macroeconomic uncertainty on corporate cash management practices. Our analysis indicates that an increase in the degree of uncertainty about macroeconomic conditions leads to an increase in corporate cash holdings even after controlling for a range of factors. We also find that the effects of macroeconomic uncertainty are particularly strong among the most financially constrained companies. Such companies increase cash holdings significantly more than the less financially constrained companies. To complete the analysis of cash management practices we show that in uncertain times firms pay out lower dividends and reduce share buybacks. These results suggest that when uncertainty is rising firms adjust payout policy to obtain additional cash which they use to hedge unpredictable future cash flows. Our empirical results are consistent with the theoretical findings made by Almeida et al. (2004) and Han and Qiu (2007).
Two important policy implications can be drawn from these results. First, if policy makers want to encourage companies to reduce their excessive cash holdings, which are sometimes referred to as “dead money”, they need to address sources of uncertainty which induces companies to accumulate cash in order to hedge unpredictable future cash flows. Second, smaller, less mature companies tend to be particularly affected by uncertain economic conditions. Well-designed policy needs to be developed that would address the problem of credit tightness and asymmetry of information between lenders and borrowers which may lead to suboptimal level of investment and excessive cash stocks in years when macroeconomic uncertainty is particularly high.
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