Product Characteristics, Competition and Dividends by Hoberg, Phillips, and Prabhala

1. Product Characteristics, Competition and Dividends by Hoberg, Phillips, and Prabhala University of Maryland Discussion byGustavo GrullonRice University

2. Motivation A large theoretical literature examines the relation between corporate financial decisions and product market behavior. Brander and Lewis (AER 1986) Bolton and Scharfstein (AER 1990) Most empirical studies focus on the interaction between capital structure and product market behavior. Chevalier (AER 1995) Phillips (JFE 1995)

3. Motivation • Recent studies examine the effects of product market competition on cash holdings and payout policy. • Haushalter, Klasa, and Maxwell (JFE 2007): Find positive correlation between cash holdings and concentration measures. • Evidence of predation risk • Grullon and Michaely (2008): Find negative correlation between payout ratios and concentration measures. • Evidence supporting agency theory (Outcome model, LLSV (JF 2000))

4. This Paper • This paper further contributes to this literature by examining the interaction between product market behavior and corporate payout policy. • Using text-based analysis of product descriptions in financial statements, the authors create several measures of product market behavior: • Product Fluidity or Instability • Product Market Competition • Product Customer Type

5. Main Results • Firms with more product fluidity have a lower propensity to distribute cash. • Product fluidity is a forward looking measure of product market risk. • More risk less dividends. • Firms with more unique products and in protected markets have a higher propensity to distribute cash. • These firms face less product market risk. • Less risk More dividends. • Firms that sell their products to other firms are more likely to pay dividends, and prefer dividends over share repurchases. • Interpretation: Dividends signal stability - this attracts business clients. • Less risk More dividends.

6. General Impression • This paper examines a very interesting and important issue in corporate finance. • I really like: (1) the new methodological approach to measure product market behavior. (2) the strong and consistent findings that firms with lower risk pay more dividends • I have some suggestions about: • The interpretation of the empirical results • The design of the empirical tests • The measures of competition • Causality

7. Comment # 1 • The main takeaway from this paper is that product market risk affects corporate payout policy. • The new measures of product market behavior, to some extent proxy for risk (a good thing, but should be recognized explicitly). • Alternative explanations: • Investment Opportunities and Growth Options • Unobservable industry effects

8. Investment Opportunities Measures of product market behavior could be proxying for investment opportunities. For example, firms with more product fluidity have better investment opportunities and growth options (e.g., Apple). Control variables may not be completely capturing investment opportunities. Market-to-book: Measurement errors, marginal vs. average q Sales growth: Backward-looking measure

9. Industry Effects Industry fixed effects are important determinants of corporate payout policy. Industry fixed effects may be capturing unobservable factors unrelated to product market risk (e.g., growth options). Table 3 show that most firms with high product market fluidity are pharmaceuticals and bio-tech firms. Is it fair to compare a bio-tech firm (Amgen) to a firm that sells corporate uniforms (Cintas)? Include industry dummies (two-digit SIC) in the regressions.

10. Comment # 2 • This paper focuses on the effects of product market behavior on the propensity to pay dividends and repurchase shares. • Limitation: It assumes that a firm with a dividend yield of 0.001% is similar to a firm with a dividend yield of 5%. • M any firms pay very low dividends just to comply with the “prudent man” rules. • Big difference in term of institutional holdings (between low div and high div firms—see Grinstein and Michaely (JF 2005) • Big differences in other characteristics. • The paper should primarily focus on the effects of product market behavior on payout levels. • Measures: Dividend yield, dividends over assets, etc. • Use Tobit regressions

11. Comment # 3 • Table 2 shows that the localized measure of concentration (HHI) is • Positively correlated with risk • Negatively correlated with size • Uncorrelated with profitability • Measures of product of market competition may be proxying for something else. • Similar to the findings using Compustat measures of concentration (Ali, Klasa, and Yeung (RFS 2009)). • May be capturing declining industries • May be capturing the effect of ignoring private firms

12. Comment # 4 • Some of the relations documented in the paper could be endogenous. ↑Payouts→ ↑Business customers ↑Business customers → ↑ Payouts • Need identification strategy to infer causality.

13. Other Issues • Use the logarithm of total risk as a control variable. • Relation between dividends and risk could be nonlinear. • Examine the effects of large changes in your measures of product market behavior on payout policy. • The matched sample analysis (Table 6) excludes ROA as a control variable. Not clear why. • Do you winsorize the data to control for outliers?

14. Conclusion • The paper examines an interesting and important issue. • Using text-based analysis to measure product market behavior is a very clever idea. • However, the authors need to do more to convince the reader that the results are consistent with their main hypothesis.