Rising Intangible Capital, Shrinking Debt Capacity, and the US Corporate Savings Glut
01 Oct 2013-Social Science Research Network (Board of Governors of the Federal Reserve System)-Vol. 2013, Iss: 67, pp 1-58
TL;DR: In this article, the authors explored the hypothesis that the rise in intangible capital is a fundamental driver of the secular trend in US corporate cash holdings over the last decades and developed a new dynamic dynamic model of corporate cash holding with two types of productive assets, tangible and intangible capital.
Abstract: This paper explores the hypothesis that the rise in intangible capital is a fundamental driver of the secular trend in US corporate cash holdings over the last decades. Using a new measure, we show that intangible capital is the most important firm-level determinant of corporate cash holdings. Our measure accounts for almost as much of the secular increase in cash since the 1980s as all other determinants together. We then develop a new dynamic dynamic model of corporate cash holdings with two types of productive assets, tangible and intangible capital. Since only tangible capital can be pledged as collateral, a shift toward greater reliance on intangible capital shrinks the debt capacity of firms and leads them to optimally hold more cash in order to preserve financial flexibility. In the model, firms with growth options tend to hold more cash in anticipation of (S,s)-type adjustments in physical capital because they want to avoid raising costly external finance. We show that this mechanism is quantitatively important, as our model generates cash holdings that are up to an order of magnitude higher than the standard benchmark and in line with their empirical averages for the last two decades. Overall, our results suggest that technological change has contributed significantly to recent changes in corporate liquidity management.
Citations
More filters
TL;DR: In this article, the Tobin's q is used to explain both physical and intangible investment, and the authors show that it is a better proxy for both physical investment and intangible capital.
Abstract: The neoclassical theory of investment has mainly been tested with physical investment, but we show it also helps explain intangible investment At the firm level, Tobin's q explains physical and intangible investment roughly equally well, and it explains total investment even better Compared to physical capital, intangible capital adjusts more slowly to changes in investment opportunities The classic q theory performs better in firms and years with more intangible capital: Total and even physical investment are better explained by Tobin's q and are less sensitive to cash flow At the macro level, Tobin's q explains intangible investment many times better than physical investment We propose a simple, new Tobin's q proxy that accounts for intangible capital, and we show that it is a superior proxy for both physical and intangible investment opportunities
465 citations
Cites background from "Rising Intangible Capital, Shrinkin..."
...For example, Gomes (2001), Hennessy and Whited (2007), and Abel and Eberly (2011) develop models predicting significant cash flow slopes even in the absence of financial frictions....
[...]
TL;DR: This paper showed that Tobin's q explains physical and intangible investment roughly equally well, and it explains total investment even better than physical investment at the firm level, compared with physical capital, which adjusts more slowly to changes in investment opportunities.
397 citations
TL;DR: The authors analyzed the effect of changes in firms' financial conditions on their price-setting behavior during the "Great Recession" that surrounded the financial crisis, finding that firms with weak balance sheets increased prices significantly relative to industry averages, whereas firms with strong balance sheets lowered prices.
Abstract: Using confidential product-level price data underlying the U.S. Producer Price Index (PPI), this paper analyzes the effect of changes in firms’ financial conditions on their price-setting behavior during the ”Great Recession” that surrounds the financial crisis. The evidence indicates that during the height of the crisis in late 2008, firms with “weak” balance sheets increased prices significantly relative to industry averages, whereas firms with “strong” balance sheets lowered prices, a response consistent with an adverse demand shock. These stark differences in price-setting behavior are consistent with the notion that financial frictions may significantly influence the response of aggregate inflation to macroeconomic shocks. We explore the implications of these empirical findings within a general equilibrium framework that allows for customer markets and departures from the frictionless financial markets. In the model, firms have an incentive to set a low price to invest in market share, though when financial distortions are severe, firms forgo these investment opportunities and maintain high prices in an effort to preserve their balance-sheet capacity. Consistent with our empirical findings, the model with financial distortions—relative to the baseline model without such distortions—implies a substantial attenuation of price dynamics in response to contractionary demand shocks.
260 citations
Journal Article•
TL;DR: A survey of the state of knowledge in the broad area that includes the theories and facts of economic growth and economic fluctuations, as well as the consequences of monetary and fiscal policies for general economic conditions can be found in this paper.
Abstract: This text aims to provide a survey of the state of knowledge in the broad area that includes the theories and facts of economic growth and economic fluctuations, as well as the consequences of monetary and fiscal policies for general economic conditions.
234 citations
TL;DR: In this paper, the authors examined the impact of independent board busyness on firm value in a setting that addresses a key challenge that the board of directors is an endogenously determined institution.
Abstract: This paper examines the impact of independent director busyness on firm value in a setting that addresses a key challenge that the board of directors is an endogenously determined institution. We use the deaths of directors and CEOs as a natural experiment to generate exogenous variation in the time and resources available to independent directors at interlocked firms. The sudden loss of such key co-employees is an ‘attention shock’ because it increases the board committee workload for some independent directors at the interlocked firm – the ‘treatment group’, but not others – the ‘control group’. In a hand-collected sample of 2,551 (592) firms that share a non-deceased independent director with 633 (189) firms subject to director (CEO) deaths, difference-in-differences estimates reveal that investors react negatively to these attention shocks. There is a significant negative stock market reaction of -0.79% (-0.95%) for director-interlocked firms in the treatment group, but no reaction for those in the control group. The treatment effect is significantly magnified by interlocking directors’ busyness (e.g., board size and number of outside directorships), the importance of their roles in the firm (e.g., type of committee membership), and their degree of actual independence (e.g., board classification). Overall, these results provide endogeneity-free evidence that independent directors’ busyness is detrimental to board monitoring quality and shareholder value.
213 citations
References
More filters
TL;DR: In this paper, two alternative linear estimators that are designed to improve the properties of the standard first-differenced GMM estimator are presented. But both estimators require restrictions on the initial conditions process.
19,132 citations
TL;DR: In this paper, a firm that must issue common stock to raise cash to undertake a valuable investment opportunity is considered, and an equilibrium model of the issue-invest decision is developed under these assumptions.
13,939 citations
Book•
01 Jan 1989
TL;DR: In this article, a deterministic model of optimal growth is proposed, and a stochastic model is proposed for optimal growth with linear utility and linear systems and linear approximations.
Abstract: I. THE RECURSIVE APPROACH 1. Introduction 2. An Overview 2.1 A Deterministic Model of Optimal Growth 2.2 A Stochastic Model of Optimal Growth 2.3 Competitive Equilibrium Growth 2.4 Conclusions and Plans II. DETERMINISTIC MODELS 3. Mathematical Preliminaries 3.1 Metric Spaces and Normed Vector Spaces 3.2 The Contraction Mapping Theorem 3.3 The Theorem of the Maximum 4. Dynamic Programming under Certainty 4.1 The Principle of Optimality 4.2 Bounded Returns 4.3 Constant Returns to Scale 4.4 Unbounded Returns 4.5 Euler Equations 5. Applications of Dynamic Programming under Certainty 5.1 The One-Sector Model of Optimal Growth 5.2 A "Cake-Eating" Problem 5.3 Optimal Growth with Linear Utility 5.4 Growth with Technical Progress 5.5 A Tree-Cutting Problem 5.6 Learning by Doing 5.7 Human Capital Accumulation 5.8 Growth with Human Capital 5.9 Investment with Convex Costs 5.10 Investment with Constant Returns 5.11 Recursive Preferences 5.12 Theory of the Consumer with Recursive Preferences 5.13 A Pareto Problem with Recursive Preferences 5.14 An (s, S) Inventory Problem 5.15 The Inventory Problem in Continuous Time 5.16 A Seller with Unknown Demand 5.17 A Consumption-Savings Problem 6. Deterministic Dynamics 6.1 One-Dimensional Examples 6.2 Global Stability: Liapounov Functions 6.3 Linear Systems and Linear Approximations 6.4 Euler Equations 6.5 Applications III. STOCHASTIC MODELS 7. Measure Theory and Integration 7.1 Measurable Spaces 7.2 Measures 7.3 Measurable Functions 7.4 Integration 7.5 Product Spaces 7.6 The Monotone Class Lemma
2,991 citations
TL;DR: In this paper, the optimal rate of investment as a function of marginal q adjusted for tax parameters is derived from data on average q assuming the actual U.S. tax system concerning corporate tax rate and depreciation allowances.
Abstract: It is increasingly recognized that Tobin's conjecture that investment is a function of marginal q is equivalent to the firm's optimal capital accumulation problem with adjustment costs. This paper formalizes this idea in a very general fashion and derives the optimal rate of investment as a function of marginal q adjusted for tax parameters. An exact relationship between marginal q and average q is also derived. Marginal q adjusted for tax parameters is then calculated from data on average q assuming the actual U.S. tax system concerning corporate tax rate and depreciation allowances. IN THE LAST DECADE and a half, the literature on investment has been dominated by two theories of investment-the neoclassical theory originated by Jorgenson and the \"q\" theory suggested by Tobin. The neoclassical theory of investment starts from a firm's optimization behavior. The objective of the firm is to maximize the present discounted value of net cash flows subject to the technological constraints summarized by the production function. It seems useful to divide the neoclassical theory into two stages. The earlier version of the neoclassical approach developed by Jorgenson [11] derives the optimal capital stock under constant returns to scale and exogenously given output. To make the rate of investment determinate, the model is completed by a distributed lag function for net investment. This earlier version of the neoclassical investment theory has a couple of drawbacks. The assumption of exogenously given output (which makes the optimal capital stock determinate) is inconsistent with perfect competition. The theory itself cannot determine the rate of investment; rather, it relies on an ad hoc stock adjustment mechanism. Some sort of adjustment costs are introduced implicitly through the distributed lag function for investment.
2,928 citations
"Rising Intangible Capital, Shrinkin..." refers background in this paper
...This negative relationship owes itself to the concavity of the value function, a feature that deviates form the neoclassical investment theory formulated by, for instance, Hayashi [1982]. Once the firm’s production capacity is reduced enough, the firm expands its capacity in bulk to its optimum capacity, at which point the Tobin’s Q exhibits a large downward jump....
[...]
TL;DR: In this paper, the authors explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets and use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle.
Abstract: We explore the determinants of liquidation values of assets, particularly focusing on the potential buyers of assets. WVhen a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves, leading to asset sales at prices below value in best use. Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage. We use this focus on asset buyers to explain variation in debt capacity across industries and over the business cycle, as well as the rise in U.S. corporate leverage in the 1980s. How DO FIRMS CHOOSE debt levels, and why do firms or even whole industries sometimes change how much debt they have? Why, for example, have American firms increased their leverage in the 1980s (Bernanke and Campbell (1988), Warshawsky (1990)), and why has this debt increase been the greatest in some industries, such as food and timber? Despite substantial progress in research on leverage, these questions remain largely open. In this paper, we explore an approach to debt capacity based on the cost of asset sales. We argue that the focus on asset sales and liquidations helps clarify the crosssectional determinants of leverage, as well as why debt increased in the 1980s. Williamson (1988) stresses the link between debt capacity and the liquidation value of assets. He argues that assets which are redeployable-have alternative uses-also have high liquidation values. For example, commercial land can be used for many different purposes. Such assets are good candidates for debt finance because, if they are managed improperly, the manager will be unable to pay the debt, and then creditors will take the assets away from him and redeploy them. Williamson thus identifies one important determinant of liquidation value and debt capacity, namely, asset redeploya
2,821 citations