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Finance and Factories

This study explores the relationship between finance and productivity in factories, using empirical finance and economic literature. It examines the effect of stock market values, trading volumes, and investor behavior on firm-level productivity. The findings have implications for corporate finance and strategic decision-making.

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Finance and Factories

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  1. Finance and Factories Warren Bailey Cornell University European Financial Management Symposium 2017 Finance and Real Economy 7th to 9th April 2017 Xiamen University 6th April 2017

  2. Why do factories interest me? Looking at lower Manhattan from Brooklyn Heights, 1960s

  3. A career in the stock market

  4. A management job in a bank

  5. Goal: A better standard-of-living

  6. Now, imagine going up the East River, not across to Manhattan

  7. Work in the brewery? No!

  8. Work in the sugar refinery? No!

  9. My career and stock markets Fama, Fisher, Jensen, and Roll, 1969, The Adjustment Of Stock Prices To New Information, International Economic Review (the first event study)

  10. Study stock market returns Brown and Warner, 1985, Using daily stock returns: The case of event studies, Journal of Financial Economics

  11. Study stock market values Tobin’s q ≈ (market value of equity + book value of debt) / book value of assets

  12. Study stock trading volume Kandeland Pearson, 1995, Differential Interpretation of Public Signals and Trade in Speculative Markets, Journal of Political Economy

  13. Study stock market investor behavior

  14. 2017: Reconsider the factory

  15. Productivity: Glimmers of a promising direction for finance Hsieh and Klenow, 2009, Misallocation and Manufacturing TFP in China and India, Quarterly Journal of Economics • Productivity should be identical across firms • Re-allocate capital to efficient firms so marginal productivity equals the market price of capital • State-subsidized finance causes firms to accept a lower marginal productivity of capital

  16. Productivity: How to measure it? • Sales/Capital? Physical output? Value-added? • Sales/Employee hours ? • Above adjusted for industry average?

  17. Cobb-Douglas production function Yi=A K βKLβLMβM • Output “Y”; inputs “K” (capital), “L” (labor), “M” (materials) • Output elasticity βK , βL , βM • Total Factor Productivity (TFP): “A”

  18. Classic empirical application Solow, 1957, Technical Change and the Aggregate Production Function, Review of Economics and Statistics • Measure aggregate US production function, 1909 to 1949, annual data • Take natural log of Cobb-Douglas, use log-differences to estimate “A” (TFP)

  19. Classic empirical application A(t) (TFP) is “a rough profile of technical change” across US economy

  20. Estimating firm/plant level TFP ln(Yit) =αjt+ βKjtln(Kijt) + βLjtln(Lijt) + βMjtln(Mijt) + εijt • i = firm/plant, j = industry, t = time period • αjt= average industry-period TFP • εijt = firm-period TFP relative to industry

  21. A simultaneity problem Olleyand Pakes, 1996, The Dynamics of Productivity in the Telecommunications Equipment Industry, Econometrica64 Levinsohn and Petrin, 2003, Estimating Production Functions Using Inputs to Control for Unobservables, Review of Economic Studies 70 • “Firms that have a large positive productivity shock may respond by using more inputs.” • Use proxies (investment, materials) for unobserved TFP and recover TFP with fitted values (multi-stage process).

  22. Survey of economics literature Syverson, Chad, 2011, What Determines Productivity?, Journal of Economic Literature • Survey, 120 references, discussions • Enormous, persistent productivity differences across firms in same industry • Competition, technology spillover, international trade, human capital, management practices, IT and R&D, regulation

  23. Example of TFP use in economics Hsieh and Klenow, 2009, Misallocation and Manufacturing TFP in China and India, Quarterly Journal of Economics • Compare China (1998 -2005) , India (1987 -1994) to US • Larger TFP dispersion by industry in China and India • US levels of productivity boost TFP by 30%–50% in China and by 40% to 60% in India • China closing the gap, India increasingly diverges

  24. Example of TFP use in economics Bloom, Draca, Van Reenen, 2016, Trade Induced Technical Change? The Impact of Chinese Imports on Innovation, IT and Productivity, Review of Economic Studies • 12 European countries; patents, IT, TFP; 1996 to 2007 • Import competition enhances technological change and shifts employment to advanced firms • Employment declines, particularly for unskilled

  25. Example of TFP use in economics Ge, Lai, and Zhu, 2015, Multinational price premium, Journal of Development Economics • Chinese manufacturing firms, 2000 to 2006, 77,087 exporters (70% of exports) matched at 8-digit level to international trade transactions from China Customs • foreign firms charge higher prices than local exporters • Relates to “knowledge-based intangible assets”, more innovative home country, TFP, seconded foreign employees, majority foreign owned

  26. TFP use in empirical finance Most obvious uses are in empirical corporate finance. Examine the effects of: • changes in ownership • corporate strategy • managerial issues • trade-offs resulting from active investors

  27. Important for finance? Lichtenberg, 1992, Corporate takeovers and productivity. Cambridge, MA: The MIT Press • “Many studies had been made of the purely financial ramifications of changes in corporate control, in particular their effect on stock prices, but little was known about the impact of takeovers on real variables such as output, productivity, employment, R&D, and fixed investment.” • Quoting Malkiel (1990), “…stock prices are in a sense anchored to certain ‘fundamentals’ but the anchor is easily pulled up and then dropped in another place.”

  28. Leveraged Buyouts and TPF Lichtenberg and Siegel, 1990, The effects of leveraged buyouts on productivity and related aspects of firmbehavior, Journal of Financial Economics • About 5% (1100) US plants in LBOs 1981 to 1986 • LBO associated with higher TFP growth compared to industry • Management buyouts have particularly strong positive effect on TFP

  29. Lichtenberg and Siegel 1990 • Use of labor and capital declines but more slowly • Administrative staff to factory workers declines • Factory worker wages rise • Plants less likely to subsequently close than other plants • R&D keeps pace with non LBO plants

  30. Corporate control and TPF Lichtenberg, 1992, Corporate takeovers and productivity. Cambridge, MA: The MIT Press • About 20,000 US plants, 1972 to 1981 • Ownership changes associated with inefficient plants, they catch up somewhat • Greatest impact on non production jobs and wages • LBO associated with efficient plants, large improvements, and reduced industrial diversification

  31. Mergers, Acquisitions, and TPF Maksimovic and Phillips, 2001,The market for corporate assets: Who engages in mergers and asset salesand are there efficiency gains?, Journal of Finance • About 50,000 plants per year, 1974 to 1992 • Average 3.89% change ownership each year • Close to 7% in In expansion years

  32. Maksimovic and Phillips 2001 • TFP gain highest when former owner is relatively inefficient or new owner is relatively productive • Plant sold from peripheral division show TFP gains • In M&A, plants placed in buyer’s main division show TFP gains • After controlling for seller and buyer characteristics, TFP gains to M&A are insignificant

  33. Maksimovic and Phillips 2001 • Buyer’s comparative advantage is in main industries • M&A premiums relate to gains in productivity • Well-run buyers apply their knowledge and improve plants they acquire • Empire building? Low-productivity buyers reduce productivity of newly acquired plants.

  34. Diversification and TFP Schoar, 2002, Effects of corporate diversification on productivity, Journal of Finance • 20366 US plant-years, 1977 to 1995 • Conglomerates relatively more productive but decline in productivity over time • Acquired plants increase productivity, existing plants suffer • Productivity is tracked by stock prices

  35. Law, management, and TFP Bertrand and Mullainathan, 2003, Enjoying the quiet life? Corporate governance and managerial preferences, Journal of Political Economy • 1976 to 1995, 224188 plant-years • When state law protects managers from takeovers, wages rise, scrapping of old plants declines, opening of new plants declines, and productivity and performance decline • Slow decay suggests preference for “quiet life”

  36. Managerial proximity and TFP Giroud, 2013, Proximity and investment: Evidence from plant-level data, Quarterly Journal of Economics • 1972 to 2005, US, 1332824 plant-years; • Airline routes and actual flights connecting US cities • When new airline route shortens time between HQ and plant, investment rises 8% to 9% and TFP rises 1.3% to 1.4%

  37. Takeovers and TFP Li, 2013, Productivity, restructuring, and the gains from takeovers, Journal of Financial Economics • 1,430 mergers, 1981 to 2002 • More efficient use of labor and capital raises productivity • Reduced capex, wages, and jobs for same output • Event study responses relate to size of productivity gains

  38. Anecdote: The Twinkie trade-off between efficiency and jobs

  39. Twinkies, profits, and jobs Bankrupt in 2012, hedge fund “rescues” Twinkies, owners benefit, but jobs are lost.

  40. Activist investors and TFP Brav, Jiang, and Kim, 2015, The Real Effects of Hedge Fund Activism: Productivity, Asset Allocation, and Labor Outcomes, Review of Financial Studies • 787,758 US plant-years, 1994 to 2007 • 2,000 hedge fund activism events • Comparison to other hedge fund investments

  41. Brav, Jiang, and Kim 2015 Plant performance rebounds with activist intervention

  42. Brav, Jiang, and Kim, 2015 Cumulative TFP relative to year of activist intervention: • Declines t-3 to t • Rises t to t+3

  43. Brav, Jiang, and Kim, 2015 Pre-intervention job losses vanish and labor productivity rises with activist intervention

  44. Brav, Jiang, and Kim, 2015 Confirm the idea that activist interventions are key: when investors switch declared status to activist, some evidence that TFP and ROA rise.

  45. Other recent work Kim, 2015, How Does Labor Market Size Affect Firm Capital Structure? Evidence from Large Plant Openings, Cornell University working paper • Large US plant openings • 2.6% to 3.9% increase in debt-to-capital ratio of local firms relative to others • Labor market deepening makes job loss less costly and reduces indirect costs of financial distress

  46. Sources of firm or plant level manufacturing data Examples I will discuss next: • US Census • China National Bureau of Statistics Another: Levinsohn and Petrin (2003) use 1979 to 1986 data on 6665 plants in Chile

  47. US Census plant-level data 1. Census of Manufacturers (CMF): all US manufacturing plants for years ending in 2 or 7 , ~300,000 plants 2. Annual Survey of Manufacturers (ASM) : 50,000 plants for “non-Census years”, always include plants > threshold number of employees, plus random plants with less • total value of shipments, capital stock and investment, labor hours, and material and energy costs

  48. US Census plant-level data • Both publicly and privately owned plants • More accurate estimation of TFP with plant-level data rather than firm-level data 3. Longitudinal Business Database (LBD): annual plant identifiers and ownership changes > 5 million manufacturing and other businesses • include the number of employees, wages, industry SIC • Problem: restricted access

  49. China firm level data Ge, Lai, and Zhu, 2015, Multinational price premium, Journal of Development Economics • annual surveys by National Bureau of Statistics (NBS) • financial and nonfinancial variables for all manufacturing firms with sales > RMB 5 million • ownership, employment, capital stock, gross output, value added, wages, industry • Problem: post 2007 lacks several key variables, notably value-added

  50. Why is NBS data so important? We can get Y, K, L, and M from annual reports or stock market databases. However: • NBS covers hundreds of thousands of firms large and small, not just a few thousand stock market listed firms • Firm TFP is computed as a residual relative to industry peers so we need a sufficient number of firms in each of approximately 400 industries • NSB has many useful variables (such as value-added for TFP calculation) as we detail later

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