This paper analyses the empirical implications of real options models on the relation between firm investment and uncertainty. Understanding how uncertainty affects investment has significant implications for policy directed toward stimulating economic activity. Studies on irreversible investment advocates a real options approach to the valuation of investment opportunities. The two crucial assumptions of literature are timing flexibility and irreversibility. Time flexibility is important because most investments are irreversible due to sunk costs. The approach of this paper is to decompose the total uncertainty faced an individual firm into its aggregate and firm specific components and then to relate these measures to firm's investment behavior. In this paper, using the q theory model of investment as a benchmark, the effect of firm uncertainty on its investment to capital ratio is examined from unbalanced panel data on Korean manufacturing firms over the period 1980 to 2002. A summary of the research is as follows.

First, The main finding is that greater uncertainty significantly reduces firm investment and that this effect is persent even after controlling for standard determinants of investment, such as Tobin's q and cash flow. The Tobin's q, cash flow, and debt ratio included in the q investment models appeared positive and statistically significant. The Tobin's q is seen to effect positively on corporate investment.  Second, total uncertainties show a negative effect that is statistically significant. And increased firm-specific and market uncertainty  adversely affects investment and greater industry uncertainty has a negative effects on firm investment. This shows that uncertainties could shrink corporate investment. Third, the interaction term of uncertainties and cash flow is found to be statistically significant and negative in the case of large companies, conglomerates, and concentrated industries. This corresponds to the argument that an increase in uncertainty reduces corporate investment irrespective of increases in the cash flow of firms. Fourth, the institutional change in the restriction on cross-equity investment was included to estimate its impact on corporate investment in conglomerates. Regarding this, changes associated with the scheme were used as dummy variables that represent policy uncertainty. The interaction term between restriction on cross equity investment and cash flow were statistically significant and negative. The frequent changes associated with restriction on cross equity investment intensified uncertainties in the management environment of conglomerates, and consequently, increases in cash flow did not lead to hikes in corporate investment. Fifth, in the case of uncertainties, huge cutbacks appeared in the investment of large companies rather than of small and medium-sized companies. It is therefore imperative that uncertainties be mitigated for large companies' investment given their huge share in total investment.

In conclusion, uncertainty tends to wither corporate investment. Specifically, uncertainty tends to cause contractions in corporate investment. Therefore, effort is needed to rid uncertainties through, for example, improving the predictability of economic policies to overcome sluggish investment.