Overinvestment and macroeconomic uncertainty: Evidence from renewable and non-renewable resource firms

Abstract

Investment is an inherent component of business activities. However, what if firms invest more than they should? This study examines this phenomenon, which is dubbed as overinvestment, among resource firms as induced by the business cycle and macroeconomic uncertainties. The analysis is conducted using unbalanced panel data drawn from 584 resource companies across 32 countries covering 1986 to 2017 in four resource sectors: (1) alternative energy, (2) forestry and paper, (3) mining, and (4) oil and gas producers. The results indicate that the forestry and paper sector overinvests relative to the standard investment level predicted by the investment function regardless of the sample period, while the alternative energy sector tends to underinvest. Also, many emerging economies, including Brazil, China, India, Indonesia, Russia, and South Korea, are found to have overinvested over the last three decades or so. In addition, the results suggest that commodity price inflation plays a more important role in inducing firms’ overinvestment than commodity price uncertainty. It is also found that the home country’s business cycle significantly affects overinvestment, with the sign alternating from negative to positive after the global financial crisis. Furthermore, the finding also shows no significant relationship between global geopolitical risk and overinvestment but a significantly positive relationship is found between global economic and country-level governance policy uncertainties and overinvestment. Lastly, the results suggest that the effect of overinvestment on firm performance after three years is positive, especially for firms in the mining sector.