Differential Impact of Uncertainty on Exporting Decision in Risk-averse and Risk-taking Firms: Evidence from Korean Firms

Abstract

(ProQuest: ... denotes formulae omitted.)I. IntroductionAs the presence of firm heterogeneity is introduced as a new channel to understand international trade, empirical research investigating links between firm heterogeneity and decision to export at the microeconomic level has prominently grown in recent decades. Some of these studies have explored differences in firms' export market participation across firms by combining fixed costs and the presence of firm heterogeneity (Melitz 2003; Greenaway et al. 2007; Chaney 2013).Melitz (2003) has theoretically proved that the presence of firm heterogeneity in terms of productivity and sunk entry costs explains why all firms do not engage in international trading activity. According to his framework, a firm forms expectations about the profitability of entry into exporting when deciding to enter or not. Thus, if expected profits of entry into exporting are high enough to cover its entry cost, then a firm chooses to serve a foreign market on a Melitz-type heterogeneous firm model.If we assume that firms are risk neutral while holding others constant, firms will enter into exporting until expected profits are equal to the entry costs, as shown in Melitz (2003). In reality, however, firms have different attitudes toward risk under uncertainty. Therefore, considering risk attitude of a firm could result in disparity from Melitz's (2003) finding, that is, firms enter into exporting as long as their expected profits are high enough to cover entry costs. For example, risk-averse firms are willing to accept lower expected profits in exchange for less exposure to risk. Conversely, risk-taking firms are willing to have more exposure to risk in exchange for higher expected profits.Greenaway et al. (2007) and Chaney (2013) consider financial dimension as an additional source of firm heterogeneity to understand export market participation. In particular, Chaney (2013) introduces financial constraints into a Melitz-type heterogeneous firm model. He proves that as participation in the international market incurs substantial start-up costs, liquidity-constrained firms face difficulty in financing such costs and consequently are less likely to export. Greenaway et al. (2007) explore the effect of financial health of UK manufacturing firms on their export market participation. Exporting firms in the United Kingdom show better financial health than non-exporting firms. However, as the degree of risk aversion of firms affects heterogeneity in the financial characteristics and exporting decision, direct and indirect effects should be analyzed.Most empirical literature that has examined the links between firm heterogeneity and entry into exporting assumes that firms are risk neutral. This assumption is criticized by Sandmo (1971), who argues that a firm's risk attitude is an important factor affecting its decision making. In particular, he points out that the results derived under the assumption that firms are risk neutral can be less informative. For example, Creusen, and Lejour (2011) find the negative effect of uncertainty on exporting decisions of firms, but they do not consider the risk attitudes of firms in their analysis. However, if a higher (lower) degree of risk aversion of firms negatively affects the exporting decisions of firms under uncertainty, the risk attitudes of firms will ruin the effect of uncertainty on exporting decisions of firms. For this reason, Creusen, and Lejour's (2011) finding in which the effect of uncertainty on the exporting decisions of firms is negative is not that convincing.In this study, we relax the strict assumption that firms are risk neutral and introduce different attitudes of firms toward risk as an additional source of firm heterogeneity. In particular, we examine how risk attitude changes the effect of uncertainty on the decision of a firm to export considering the different types of uncertainty faced by the firm, namely, firm-specific and macroeconomic. …