The Industry Life-Cycle and Financial Dependence: Does Firm Organization Matter? Vojislav Maksimovic Gordon Phillips University of Maryland

Overview Does a firm’s organization predict how it invests in a market? Specifically we ask: 1. Does a firm’s organization predict its capital expenditures, acquisitions, plant births and closings? 2. Does the effect of organizational structure differ across competitive environments? 3. What is the role of: –financial/resource dependence –access to public capital markets

Main Findings: Much of the literature addresses differences in CAPEX across organizational types –These differences may be quite small. –Differences in acquisitions across types are economically significant. In summary stats, single-segment firms are more financially/resource dependent. –In declining industries – low productivity firms are financially dependent –In growing industries – low and high productivity firms are financially dependnent Conglomerates do mitigate the effect of financial dependence on acquisitions  no evidence of misallocation Differences in acquisition rates are more significant for high-growth industries. Evidence that conglomerate acquisitions in high growth industries add value.

Our approach differs because: Literature has focused on the effect of firm organization on capital expenditures and has not generally studied the effect of firm organization on births, acquisition and closure decisions. Competitive environment focus We address these questions using a plant-level panel data from the LRD (US Census)

Conglomerates and Investment Differences between conglomerates and single-segment firms –Conglomerates misallocate investment -- agency view: Shin and Stulz (1997), Rajan, Servaes and Zingales (2000), Scharfstein and Stein (2000) –Conglomerates provide efficient capital market –Comparative advantage/ neo-classical view view – firms become conglomerates because they have competencies/organizational culture that creates value in several industries ---e.g., Maksimovic and Phillips (2002) These differences may affect CAPEX, acquisitions and plant deaths differently. Differences may depend on the competitive environment

Questions that need to be addressed: Why the contradictory results ----? –Data/technique differences? –Measuring different things? What is the role of organizational form? –Is it the internal capital market? –Does organizational form come with differences in investment? Do particular organizational forms have a comparative advantage in some competitive environments? Nature of the exercise: –Data analysis to point the way for modeling.

Implications of neo-classical approach

Empirical version

Our Basic Specification Financial deficit  Segment’s cash flows < CAPEX Predict the expected financial deficit Expected financial deficit =f( productivity, firm size, industry growth, capital intensity) Basic specification: INV=a+b*Productivity + c*Expected Financial deficit + Controls Org structure: INV=a+b*Productivity + c*E(Financial deficit) +d*Org Form + e* (E(Financial deficit)*Org Form) + Controls Examine: –Different types of INV –Different competitive environments. Financial dependence is a descriptive concept  does NOT necessarily imply that firm is constrained.

Industries differ Split industries by 25 year change in the real value of shipments ( ), and examine the change in the numbers of firms. In both declining and growing industries large differences in the change in the number of firms. Especially in growing industries a decline in the number of producers of 30% is non uncommon.

Industry classification We split our industries into four categories: 1. Declining industries in which long-run demand and the long-run number of firms are both decreasing 2.Technological change industries in which long-run demand is decreasing but the number of firms is increasing 3. Consolidating industries in which long-run demand is increasing but the number of firms is decreasing 4. Growth industries in which long-run demand and the long run number of firms are both increasing

Data Data from the Center for Economic Studies, U.S. Department of Commerce. 50,000+ plants per year, 500,000+ firm-segment years, Plants are assigned to 4 digit SIC code. Multi-division firms are thus not assigned to one SIC code. Aggregate up into 3 digit industry segments for each firm for each year using value of shipments. Single segment if secondary segments < 10 % shipments. Identification of whether or not the firm is publicly traded in the U.S.

Productivity Benchmarking Plant-level benchmarking: Three inputs, capital, labor, and materials: as explanatory variables. Output: value of shipments. Adjust for inflation and depreciation adjustments. Include plant age. Different ways of estimating productivity: ∙ –plant level v. firm-segment level –rolling panels (5 years lagged data) v. full period ∙ –firm-segment fixed effects and plant-level productivity

Our Basic Specification Financial deficit  Segment’s cash flows < CAPEX Predict the expected financial deficit Expected financial deficit =f( productivity, firm size, industry growth, capital intensity) Org structure: INV=a+b*Productivity + c*E(Financial deficit) +d*Org Form + e* (E(Financial deficit)*Org Form) + Controls

Long-run Industry Effects and Plant Acquisitions

Robustness: breakdown into high and low productivity segments

Table 6: Productivity Changes after Plant Acquisitions

Could the results be driven by the relationship of units within conglomerates? Patterns might be induced by –Correlated demand shocks between main and peripheral units –Transfer pricing across units We used input-output tables to determine whether a peripheral unit’s industry buys/sells from a main unit’s industry. The results hold on the subsample of segments that do not buy/sell from the main/unit’s industry

Main Findings: Much of the literature addresses differences in CAPEX across organizational types –These differences may be quite small. –Differences in within-industry acquisitions across types are economically significant. In summary stats, single-segment firms are more financially dependent. Dependence could be financial – could be lower organizational ability. –In declining industries – low productivity firms are financially dependent –In growing industries – low and high productivity firms are financially dependent Conglomerates do mitigate the effect of dependence on acquisition Differences in acquisition rates are more significant –For high-growth industries. –For efficient businesses in high-growth industries Evidence that conglomerate acquisitions in high growth industries add value. Conglomerates more likely to close down plants in declining industries.

Implications How do conglomerates differ? –They mitigate dependence, especially for efficient businesses –They acquire more within their existing industries. –They are more likely to close plants. –They are bigger and more efficient…. Differences most pronounced in growth industries. Acquisitions by conglomerates result in increased productivity --- particularly in growth industries. A broader question: –How much is driven by financial and how much by real factors?

Ongoing research …. Following an acquisition approx 40% of the target’s plants are sold within 4 years. In particular plants that do not belong to main divisions are sold. Do acquisitions create an externality?