Time to build capital: Revisiting investment-cash-flow sensitivities

A large body of empirical work has established the significance of cash flow in explaining investment dynamics. This finding is further taken as evidence of capital market imperfections. We show, using a perfect capital markets model, that time-to-build for capital projects creates an investment-cash-flow sensitivity as found in empirical studies that may not be indicative of capital market frictions. The result is due to mis-specification present in empirical investment-q equations under time-to-build investment. In addition, time aggregation error can give rise to cash-flow effects independently of the time-to-build effect. Importantly, both errors arise independently of potential measurement error in q. Evidence from a large panel of U.K. manufacturing firms confirms the validity of the time-to-build investment channel.     

R&D and Tobin's q in an emerging financial market: the case of the Athens Stock Exchange

This paper aims at providing further evidence on the consequences of R&D investment on Tobin's q for firms publicly traded in an emerging financial market. Panel data methodology is applied using data for the manufacturing and computer firms listed in the Athens Stock Exchange, a market classified as emerging by the major securities analysts, for the period 1996–2004. The empirical findings show first, that the Greek firms' R&D investment effect on the market value of a firm is consistent with other US and European studies. Second, the impact of the R&D investment on the market value is higher for small firms. The findings of this paper may have significant industrial and technological policy implications for other emerging markets sharing similar characteristics to Greece. Copyright © 2010 John Wiley & Sons, Ltd.     

Assessing the importance of measurement error in capital investment models

New developments in the economics of capital investment emphasize the role of financial variables. Econometric evidence on these hypotheses is potentially compromised by measurement error due to accounting conventions. The paper reviews new capital investment models and considers ways in which accounting procedures might lead to measurement error biases. Advances in errors-in-variables econometric models are employed to gauge the impact of measurement error on estimates of financial influences on capital investment. Cash-flow models appear to be especially susceptible to measurement error but q models seem fairly insensitive to measurement problems.     

Games Hospitals Play: Entry Deterrence in Hospital Procedure Markets

Strategic investment models, though popular in the theoretical literature, have rarely been tested empirically. This paper develops a model of strategic investment in inpatient procedure markets, which are well-suited to empirical tests of this behavior. Potential entrants are easy to identify in such markets, enabling the researcher to accurately estimate the entry threat faced by different incumbents. I derive straightforward empirical tests of entry deterrence from a model of patient demand, procedure quality, and differentiated product competition. Using hospital data on electrophysiological studies, an invasive cardiac procedure, I find evidence of entry-deterring investment. These findings suggest that competitive motivations play a role in treatment decisions.     

The Relative Price of Non‐traded Goods under Imperfect Competition*

We consider the role of imperfect competition in explaining the relative price of non‐traded to traded goods within the Balassa–Samuelson framework. Under imperfect competition in these two sectors, relative prices depend on both productivity and mark‐up differentials. We test this hypothesis using a panel of sectors for 12 OECD countries. The empirical evidence suggests that relative price movements are well explained by productivity and mark‐up differentials.     

Optimal Hedging Strategies and Interactions between Firms

This paper studies corporate risk management in a context of financial constraints and imperfect competition in the product market. The paper shows that interactions between firms affect their hedging strategies. As a general rule, firms’ hedging demands decrease with the correlation between their internal funds and investment opportunities. Moreover, when a firm’s hedging demand is high in the case where investments are strategic substitutes, its hedging demand is low in the case where investments are strategic complements and vice versa.     

Multiple capital inputs, Q, and investment spending

Despite their explicit treatment of dynamics and solid theoretical basis, investment models based on the Brainard-Tobin Q have recorded a generally disappointing empirical performance. When the Q model is expanded to recognize the possibility that the value of the firm depends on two or more capital inputs with differing adjustment cost technologies, the econometric equation following from optimizing behavior includes Q as well as a set of additional explanatory variables. The importance of these omitted variables is assessed, and the capital homogeneity assumption for equipment and structures implicit in Conventional Q models is rejected. The Multi-Capital Q model is then extended in two ways: (i) adding inventory, research and development, and labor as quasi-fixed factors and (ii) exploring the sensitivity of the instrumental variables estimates to normalization. We conclude that the Multi-Capital Q model is a useful extension that overcomes an important omitted variables problem in the Conventional Q framework.     

Can buyer “mobility” reduce aggregation failures in land-assembly?

In this paper we examine whether site-development competition can be used to facilitate land assembly, in the absence of contingent contracts. In particular, we attempt to determine (1) whether competition can be induced among prospective sellers, (2) whether or not competition increases aggregation rates, and (3) what effects competition has on the distribution of surplus among the bargaining parties. We also study the incidence with which a buyer (endogenously) chooses to deal with a single “large parcel” owner vs. multiple “small parcel” owners. To do so, we make use of a laboratory experiment where all the relevant information about the project is common knowledge and landowner valuations are private information. Our results show that competition more than doubles aggregation rates, with aggregation rates of approximately 40% in the baseline, and at least 84% in the competitive treatments. We also find that developers have a strong preference to make transactions with landowners who have consolidated land holdings, doing so in 24/27 successful aggregations, providing empirical evidence that there is a link between the transactions cost associated with land-assembly and suburbanization, as suggested by Miceli and Sirmans (2007).     

Hostile–vs.–white‐knight bidders

We examine the hypothesis that white knights enter control contests to spend free cash flow instead of paying it out to shareholders. Tobin's q is used to measure management's inclination to invest in negative NPV investments. We find that historically, white knights have over‐invested and their acquisition of the target is one more negative NPV investment. Alternatively, hostile bidders’ past investment decisions have increased shareholder wealth. Furthermore, white knights’ returns upon the announcement of their bid have a significant negative relationship with free cash flow, implying that their bid reveals information about white knights management's investment decisions. Copyright © 1999 John Wiley & Sons, Ltd.     

Do Greenhouse Gas Emissions Affect Financial Performance? – an Empirical Examination of Australian Public Firms

Previous studies that have attempted to relate corporate environmental performance to financial performance have generated conflicting results. This paper presents the findings of a study on the relationship between greenhouse gas (GHG) emissions and the financial performance of Australian corporations. Using multiple regression models and data from a sample of 69 Australian public companies, this paper finds a positive correlation between GHG emissions and corporate financial performance. By testing the statistical significance of GHG emission factors in determining company Tobin's q, this study finds that a stronger Tobin's q often correlates with higher GHG emissions across all industry sectors. This finding is contrary to evidence found in previous studies conducted in other countries. The positive correlation found in this study could be explained with reference to the unique economic structure and development of Australia, particularly its dominant mining industry. Copyright © 2013 John Wiley & Sons, Ltd and ERP Environment     

Management ownership and corporate value

Existing literature on the relation between management ownership and firm value has provided competing hypotheses and conflicting evidence. Using samples of Fortune 500-sized firms in 1976, 1980 and 1984, we find that corporate value measured by Tobin's q is a function of management ownership. Specifically, the q rises when management ownership is between 0% and 5-7%, and falls as the ownership increases to 10-12%. Beyond this range, we find that the q continues to fall in the 1976 sample, and starts to rise in the 1980 and 1984 samples. The evidence supports the hypothesis that there is a nonmonotonic relation between management ownership and corporate value.     

Cartel dating

The begin and end dates of cartels are often ambiguous, despite competition authorities stating them with precision. The legally established infringement period(s) from documentary evidence need not coincide with the period(s) of actual cartel effects. In this paper, we show that misdating cartel effects leads to a (weak) overestimation of but‐for prices and an underestimation of overcharges. Total overcharges based on comparing but‐for prices to actual prices are a (weak) underestimation of the true amount overcharged, irrespective of the type and size of the misdating. The bias in antitrust damage estimation based on predicted cartel prices can have either sign. We extend the before‐during‐and‐after method with an empirical cartel dating procedure, which infers structural breaks of unknown number and dates that mark the actual begin and end dates of the collusive effects. Empirical findings in the European Sodium Chlorate cartel corroborate our theoretical results.     

Dynamic contracting under imperfect public information and asymmetric beliefs

We develop a dynamic principal–agent model to show how imperfect public information and asymmetric beliefs about payoff-relevant parameters, agency conflicts, and the agent's implicit incentives to influence the principal's posterior beliefs through his unobservable actions interact to affect optimal dynamic contracts. We make a methodological contribution to the literature by solving the continuous-time contracting problem using a discrete-time approximation approach. We obtain a simple characterization of optimal renegotiation-proof contracts in terms of the solution to a nonlinear ordinary differential equation (ODE). We then exploit the properties of the ODE to derive a number of novel implications for the dynamics of long-term contracts that alter the intuition gleaned from the previous literature. Optimism has a first-order impact on incentives, investment and output that could reconcile the “private equity” puzzle. Consistent with empirical evidence, the interaction between asymmetric beliefs, risk-sharing and adverse selection costs could cause the time-paths of the agent's incentive intensities to be increasing or decreasing. Our results also suggest that the incorporation of imperfect public information and asymmetric beliefs could potentially reconcile empirical evidence of an ambiguous relation between risk and incentives, and a non-monotonic relation between firm value and incentives. Permanent and transitory components of risk have differing effects on incentives, which suggest that empirical investigations of the link between risk and incentives should appropriately account for different components of risk.     

Dividend policy and investment: Theory and evidence from US panel data

This paper examines the importance of dividend policy and liquidity constraints in the context of the firm's investment behaviour. While early financial literature has argued that dividend policy should be independent of firm investment decisions, recent studies indicate that linkages are probable in a world of imperfect capital markets. This study develops an alternative Q specification which incorporates the actual dividend payment of the firm in order to test the hypothesis of independence. Empirical results suggest that after controlling for the firm's dividend payment, liquidity constraints remain an important determinant of firm investment behavior.     

Credit vs. demand constraints: The determinants of US firm-level investment over the business cycles from 1977 to 2011

The paper studies empirically how relative supply and demand conditions on the capital market affected US firm-level investment over the business cycles from 1977 to 2011. A dynamic econometric specification of capital accumulation including sales growth, Tobin's q, the cash flow-capital ratio and the cost of capital as covariates is fitted by a rolling window System GMM estimator using quarterly data on publicly traded US corporations in order to obtain time-varying coefficients. We find that the investment effects of the variables capturing the demand-side of the capital market, i.e. sales growth and Tobin's q, behave counter-cyclically, whereas this does not hold for the investment effects of supply-side variables such as cash flow or the cost of capital. Our results suggest that investment was typically driven by adverse demand rather than supply conditions on the capital market during the most severe recessions.     

Asset specificity,capital intensity and capital structure: An empirical test

Capital investment and capital financing decisions interact. To resolve current controversies in investment-leverage-growth relationships requires an integrated industrial organization/financial economics empirical model of profit margins, capital investment intensity, leverage and risk. Using cumulative future losses in discontinued operations to measure the asset specificity of the firm's investments, empiricai results support a complementary (positive) relationship between debt and investment, the debt financing of verifiable contemporaneous growth, equity financing of future growth and the debt financing of specific assets. This evidence rejects the transactions cost theory of capital structure in Fortune 500 firms.     

Estimation and testing of Euler equation models with time-varying reduced-form coefficients

This paper studies the estimation and testing of Euler equation models in the framework of the classical two-step minimum-distance method. The time-varying reduced-form model in the first step reflects the adaptation of private agents’ beliefs to the changing economic environment. The presumed ability of Euler conditions to deliver stable parameters indexing tastes and technology is interpreted as a time-invariant second-step model. This paper shows that, complementary to and independent of one another, both standard specification test and stability test are required for the evaluation of an Euler equation. As an empirical application, a widely used investment Euler equation is submitted to examination. The empirical outcomes appear to suggest that the standard investment model has not been a success for aggregate investment.     

Racing To Invest? The Dynamics of Competition in Ethical Drug Discovery

Recent advances in the theoretical literature have greatly expanded our understanding of the forces that shape the competitive dynamics of research and development, but a paucity of sufficiently detailed empirical data has left these insights relatively untested. We draw on unusually detailed qualitative and quantitative infernal data provided at the research program level by 10 major pharmaceutical firms to explore the usefulness of the modern literature as a source of insight into the dynamics of competition in ethical drug discovery. Our analysis focuses on one particularly compelling aspect of the literature: the suggestion that in “winner take all situations,” competition in R&D becomes a Prisoner's Dilemma, leading to overinvestment in research. Without adequate measures of the social return to innovation, we can say nothing about whether there is “too much” or “too little” research undertaken by the industry, but our results do not support the suggestion that R&D investment in drug discovery is driven by the “tit-for-tat” or simple reaction function models hinted at by the institutional literature. First, R&D investment is only weakly correlated across firms once common responses to exogenous shocks are accounted far, and second, rivals' R&D results are positively correlated with own research productivity, which we interpret as evidence for extensive R&D spillovers rather than the depletion externality implied by “winner take all” models. These results are not, of themselves, sufficient to reject the hypothesis that investment behavior in the industry is driven by strategic considerations since there is theoretical support for a wide variety of observable behavior as equilibrium outcomes of strategic interaction. Nonetheless, they suggest that the more extreme forms of rent dissipation identified in the literature are probably poor characterizations of the reality of competition in pharmaceuticals. Our results point both to the need to develop theories that incorporate richer models of possible payoff structures, adjustment costs, and firm heterogeneity and to the need to collect empirical data that is comprehensive enough to enable one to test them.     

The serial correlation structure for a random process with steps

Summary We derive the detailed correlation structure for the simple “staircase model”: a process where white noise is superimposed on a deterministic step function that has equal rises and equal treads. It turns out that this structure is an immediate generalisation of that for a linear trend (which, for discrete data, can be alternatively considered as a step function with equal rises and unit treads). We compare the structure obtained with that for a random walk, and those for a subset of other ARIMA(p, 1,q) models, and those of general ARIMA(p, d, q) processes withd>1.     

Zipf's Law for Cities and Beyond: The Case of Denmark

Zipf's law for cities is one of the most conspicuous and robust empirical facts in the social sciences. It says that for most countries, the size distribution of cities must fit the power law: the number of cities with populations greater than S is inversely proportional to S. The present paper answers three questions related to Zipf's law: (1) does the Danish case refute Zipf's law for cities?, (2) what are the implications of Zipf's law for models of local growth?, and (3) do we have a Zipf's law for firms? Based on empirical data on the 61 largest Danish cities for year 2000, the answer to (1) is NO—the Danish case is not the exception which refutes Zipf's law. The consideration of (2) then leads to an empirical test of (3). The question of the existence of Zipf's law for firms is tested on a sample of 14,541 Danish production companies (the total population for 1997 with 10 employees or more). Based on the empirical evidence, the answer to (3) is YES in the sense that the growth pattern of Danish production companies follows a clean rank‐size distribution consistent with Zipf's law.