Comovement in Investment

1. Comovement in Investment (A. Knyazeva, D. Knyazeva, R. Morck, B. Yeung) EFM Symposium - 2009 Comovement

2. Overview • Motivation and background • The argument • Data and results • Conclusions and future work Comovement

3. Background: related work • Herding • Return comovement. Morck, Yeung, & Yu 2000 • Distortions in firm investment: low sensitivity to value added, high sensitivity to cash flow; low risk • Law and finance: investor and property rights protection affects financial development, ownership concentration, corporate valuation, cash and dividend policies. LLSV. Comovement

4. This paper • Is there comovement in firm investments? • After controlling for firm similarities and economic characteristics, correlation in investment decisions is due a common subset of information. • Can we explain it by agency, information asymmetry? • Are there gains from information acquisition, is CI distortionary? Comovement

5. The “how”: information acquisition • Firms can “discover” (acquire) value-relevant information about investment projects • Such information is private and costly, so firms can instead use less accurate, public information • Tradeoff  endogenous information acquisition • Investments based on similar information result in the observed higher comovement (CI) • Several reasons for suboptimally low information acquisition and high CI Comovement

6. “Why”: Agency • Investors delegate investment and information acquisition decisions to managers • Information acquisition effort  agency conflict (The manager bears the cost but does not absorb the full benefit of higher firm value) • H1: Stronger governance  Less Comovement • Alternative argument: entrenched managers face fewer career concerns (Scharfstein and Stein 1990, Stein 2003) / relative performance evaluation (Maug and Naik 1996)  herd less Comovement

7. “Why”: information asymmetry • Information asymmetry: private investment information is not verifiable. In anticipation of added scrutiny, higher cost of capital, managers invest based on public information  comovement. • Disclosure standards and analyst forecasts can mitigate the information asymmetry • H2: Lower information asymmetry  Less Comovement Comovement

8. “Why”: Property rights • Expropriation of private property rights:rent-seeking/threat of expropriation by the public sector  lower cash flows, lower gains to information acquisition  more comovement • H3: Better Property Rights  Less Comovement Comovement

9. Other determinants of comovement • Ownership concentration (?) • Similar growth and investment opportunities (+) • Correlated cash flows * financial constraint (+) • Dependence on external equity markets (-/?) • Common shocks (high-tech firms) (+) • Low asset specificity (many tangible assets) (+) • Industry concentration (product markets) (+) • Macro level: volatility (+), weak financial development (+); income (-) Comovement

10. Performance effects of comovement • C.p., underuse of private information leads to • less optimal allocation of capital to investment projects (accept NPV-, forgo NPV+ projects) and • to forgoing firm-specific improvements in investment technology • The result is decreased performance and lower productivity growth (at the country level) • H4: High comovement  Lower performance Comovement

11. Data and variables • Compustat Global Industrial / Global Issues for data on firm characteristics for 1994-2004 • In firm-level analyses, use S&P’s Transparency and Disclosure data (1998-2002) • Exclude financials and utilities, obs. with missing data, and country-years with fewer than 10 obs. • Firm-level propensity to comove with the industry investment trend; comovement index constructed similarly to Morck, Yeung, and Yu 2000 • TFP growth - similarly to John et al. 2007 • Performance regressions: 3-year MA of lags, IV Comovement

12. Determinants of CI: Industry, Intl (Table 2) Comovement

13. Determinants of CI: Firm-level, Intl (Table 3) Comovement

14. Determinants of CI: Firm-level, US (Table 5) Comovement

15. Performance effects of CI: Firm & Industry, US (Table 7) Comovement

16. Conclusions and future work • As with investors and fund managers, we find that some firms mimic each other’s investment decisions • Less stringent monitoring of the management lowers costly information acquisition effort and leads to excessive reliance on public investment information • Firms faced with high information asymmetry similarly conform to the common trend • Legal environment features such as weak shareholder and property rights are also associated with higher comovement in investment Comovement

17. Conclusions and future work (cont) • Tested other explanations for differences in CI, including similar investment opportunities (+), common shocks (+), low asset specificity (+), financial constraints, concentrated ownership • Bottom-line effects: distortionary effect of high comovement on performance and growth, c.p. • Potential extension: differences across economic cycles; • Implication: can explain return comovement and inefficient investment allocation Comovement