The cyclicality of cash flow and investment in U.S. manufacturing

Cash flow ; Manufactures

Financing Constraints and Corporate Investment

Most empirical models of investment rely on the assumption that firms are able to respond to prices set in centralized securities markets (through the "cost of capital" or "q"). An alternative approach emphasizes the importance of cash flow as a determinant of investment spending, because of a "financing hierarchy," in which internal finance has important cost advantages over external finance. We build on recent research concerning imperfections in markets for equity and debt. This work suggests that some firms do not have sufficient access to external capital markets to enable them to respond to changes in the cost of capital, asset prices, or tax-based investment incentives. To the extent that firms are constrained in their ability to raise funds externally, investment spending may be sensitive to the availability of internal finance. That is, investment may display "excess sensitivity" to movements in cash flow. In this paper, we work within the q theory of investment, and examine the importance of a financing hierarchy created by capital-market imperfections. Using panel data on individual manufacturing firms, we compare the investment behavior of rapidly growing firms that exhaust all of their internal finance with that of mature firms paying dividends. We find that q values remain very high for significant periods of time for firms paying no dividends, relative to those for mature firms. We also find that investment is more sensitive to cash flow for the group of firms that our model implies is most likely to face external finance constraints. These results are consistent with the augmented model we propose, which takes into account different financing regimes for different groups of firms. Some extensions and implications for public policy are discussed at the end.

Market Structure and Cyclical Fluctuations in U.S. Manufacturing

The relevance of imperfect competition for models of aggregate economic fluctuations has received increased attention from researchers in both macroeconomics and industrial organization. Measuring properly the size of industry markups of price over marginal cost is important both for assessing the role of market structure and for determining the extent to which excess capacity is a significant feature accompanying imperfect competition in American industry. Using a panel data set on four-digit Census manufacturing industries, this paper expands recent work by Robert Hall on the importance of market structure for understanding cyclical fluctuations. We outline a methodology for estimating industry markups of price over cost and the influence of market structure on cyclical movements in total factor productivity. While we find evidence to support the proposition that price exceeds marginal cost in U.S. manufacturing, our results offer only limited support for the notion that markups are importantly related to differences in industry concentration, though the effect of unionization is important. Concentration effects are important only in industries producing durable goods or differentiated consumer goods. In addition, much of the estimated markup of price over marginal cost is accounted for by fixed costs related to overhead labor, advertising, and central office expenses; we do not find compelling evidence of substantial evidence of excess capacity in most industries.

Business Cycles and Oligopoly Supergames: Some Empirical Evidence on Prices and Margins

There has been a significant interest on a theoretical level in the application of supergames to oligopoly behavior. Implications for pricing behavior in trigger-strategy models in response to aggregate demand are of particular importance for public policy considerations. We contrast the predictions for the movements of industry prices over the business cycle of two such models -- put forth by Edward Green and Robert Porter and by Julio Rotemberg and Garth Saloner -- and test the predictions using a panel data set of U.S. manufacturing industries. Our principal findings are four. First, the levels of price-cost margins of concentrated, homogeneous-goods industries, while higher than those of unconcentrated counterparts, appear to be closer to those predicted by a single-period Cournot-Nash equilibrium than monopoly. Second, there is little evidence to support the idea that price-cost margins of these industries have different cyclical patterns from other industries apart from effects by level of industry concentration. Maximum price declines for concentrated industries give little support for the occurrence of price wars during either recessions or booms. Finally, consistent with the predictions of the Rotemberg-Saloner model, the industries with high price-cost margins have more countercyclical price movements than those exhibited by other industries. That gradual price adjustment is quantitatively important for those industries, suggests, however, that other factors may lie behind the apparent rigidity of prices.

Financing Constraints and Corporate Investment

macroeconomics, Financing Constraints, Corporate Investment

Inventory Investment, Internal-Finance Fluctuation, and the Business Cycle

macroeconomics, inventory investment, internal-finance fluctuation, business cycle

Financing Constraints and Corporate Investment: Response to Kaplan and Zingales

Kaplan and Zingales (1995, hereafter KZ) criticize Fazzari, Hubbard and Petersen (1988, hereafter FHP) and much ensuing research that uses cross-sectional differences in firm behavior to test for financing constraints on investment. This reply identifies flaws in the KZ analysis. The questions KZ raise have been considered extensively and rigorously in the literature (most of which is not addressed in KZ), with results broadly similar to those of FHP. We also challenge both of KZ's main results. First, their finding that most of the FHP firms are not financially constrained relies on an inappropriate operational definition of what it means to be constrained. Their definition ignores the incentives for firms that operate in imperfect capital markets to accumulate stocks of cash or maintain unused debt capacity to offset partially shocks to the flow of internal finance. Second, the KZ regression results (lower sensitivity of investment to cash flow for firms classified as constrained than for those classified as unconstrained) are uninformative. Their classification approach relies on possibly self- serving managerial statements that may present a distorted picture of firm's availability of finance. It also employs misleading criteria to make unrealistically fine distinctions in the degree of financing constraints, and emphasizes financial distress rather than financing constraints. Finally, econometric problems affect the interpretation of the KZ regressions. We conclude that the KZ findings do not contradict the interpretation of the empirical results in FHP and subsequent research.

Investment cyclicality in manufacturing industries

Industries ; Business cycles ; Investments

Utilizing National Agriculture Imagery Program Data to Estimate Tree Cover and Biomass of Piñon and Juniper Woodlands

With the encroachment of piñon (Pinus ssp.) and juniper (Juniperus ssp.) woodlands onto sagebrush steppe rangelands, there is an increasing interest in rapid, accurate, and inexpensive quantification methods to estimate tree canopy cover and aboveground biomass. The objectives of this study were 1) to evaluate the relationship and agreement of piñon and juniper (P-J) canopy cover estimates, using object-based image analysis (OBIA) techniques and National Agriculture Imagery Program (NAIP, 1-m pixel resolution) imagery with ground measurements, and 2) to investigate the relationship between remotely-sensed P-J canopy cover and ground-measured aboveground biomass. For the OBIA, we used eCognition® Developer 8.8 software to extract tree canopy cover from NAIP imagery across 12 P-J woodlands within the Sagebrush Steppe Treatment Evaluation Project (SageSTEP) network. The P-J woodlands were categorized based on the dominant tree species found at the individual sites for the analysis (western juniper, Utah juniper, and mixed P-J community). Following tree canopy cover extractions, relationships were assessed between remotely-sensed canopy cover and ground-measured aboveground biomass. Our OBIA estimates for P-J canopy cover were highly correlated with ground-measured tree canopy cover (averaged across all regions r = 0.92). However, differences between methods occurred for western and Utah juniper sites (P \u3c 0.05), and were more prominent where tree canopy cover was \u3e 40%. There were high degrees of correlation between predicted aboveground biomass estimates with the use of remotely-sensed tree canopy cover and ground-measured aboveground biomass (averaged across all regions r = 0.89). Our results suggest that OBIA methods combined with NAIP imagery can provide land managers with quantitative data that can be used to evaluate P-J woodland cover and aboveground biomass rapidly, on broad scales. Although some accuracy and precision may be lost when utilizing aerial imagery to identify P-J canopy cover and aboveground biomass, it is a reasonable alternative to ground monitoring and inventory practices