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Information, capital markets, and investment.

Information, Capital Markets, and Investment

The NBER held a conference on "Information, Capital Markets, and Investment" in Cambridge on May 5-6. Research Associate R. Glenn Hubbard of Columbia University organized the following program:

Bruce C. Greenwald, Bell Communications Research;

Joseph E. Stiglitz, NBER and Stanford University;

and Andrew Weiss, NBER and Boston University,

"Models of Equity and Credit Rationing"

Discussant: Mark Gertler, NBER and University of


Roger E. A. Farmer, University of California at Los

Angeles, "A.I.L. Theory and the Ailing Phillips Curve:

A Contract-Based Approach to Aggregate Supply"

(NBER Working Paper No. 3115)

Discussant: R. Glenn Hubbard

William A. Brock and Blake LeBaron, University of

Wisconsin, "Liquidity Constraints in Production-Based

Asset Pricing Models" (NBER Working

Paper No. 3107)

Discussant: Bruce N. Lehmann, NBER and Columbia


Michael Devereux, Institute for Fiscal Studies,

London; and Fabio Schiantarelli, Boston University,

"Investment, Financial Factors, and Cash Flow:

Evidence from U.K. Panel Data" (NBER Working

Paper No. 3116)

Discussant: Jeffrey K. MacKie-Mason, NBER and

University of Michigan

Peter C. Reiss, NBER and Stanford University, "The

Economic and Financial Determinants of Oil and

Gas Exploration Activity" (NBER Working Paper

No. 3077)

Discussant: John Meyer, Harvard University

John Meyer, and John Strong, College of William and

Mary, "Free Cash Flow and Discretionary

Investment: A Residual-Funds Study of the Paper Industry"

Discussant: Steven M. Fazzarri, Washington


William Gale, University of California at Los Angeles,

"Information, Collateral, and Government

Intervention in Credit Markets" (NBER Working Paper

No. 3083)

Discussant: Andrew Weiss

Jeffrey K. MacKie-Mason, "Does Internal Financing

Differ from External?"

Discussant: David Scharfstein, MIT

Colin Mayer, City University, London, "Financial

Systems, Corporate Finance, and Economic


Discussant: Roger E. A. Farmer

Robert A. Korajczyk and Deborah Lucas,

Northwestern University; and Robert L. McDonald, NBER

and Northwestern University, "Stock Price and

Earnings Behavior Around the Time of Equity Issues"

Discussant: Jeremy Stein, Harvard University

Takeo Hoshi, University of California at San Diego;

Anil Kashyap, Federal Reserve Board; and David

Scharfstein, "Bank Monitoring and Investment:

Evidence from the Changing Structure of Japanese

Corporate Banking Relationships" (NBER Working

Paper No. 3079)

Discussant: James Kahn, University of Rochester

John Pound, Harvard University; and Richard J.

Zeckhauser, NBER and Harvard University, "Are Large

Shareholders Effective Monitors? An Investigation

of Share Ownership and Corporate Performance"

Discussant: Gary Gorton, University of Pennsylvania

Greenwald, Stiglitz, and Weiss consider the effects on investment decisions of equity and credit rationing at the firm level. They model the banking sector, which is assumed to be effectively constrained in raising new equity capital. The availability of credit to firms depends on the financial condition (accumulated internal net worth) to both firms and the banking sector, reinforcing the accelerator mechanism in investment. In the short run, the effects of monetary policy on investment and output are magnified through relaxation of financing constraints. Long-run dynamics are driven by rates of accumulation in capital and internal equity.

Farmer focuses on movements in interest rates in bringing about Phillips curve correlations in data. He stresses the role of the nominal interest rate: for the firm, the optimal contract trades off the opportunity cost of holding liquid balances against the benefits of additional liquidity. The benefits arise from the fact that liquidity buffers permit firms to offer more stable wages, facilitating more efficient employment decisions. Using data for the United States for 1931-86, Farmer finds that movements in the unemployment rate are negatively correlated with movements in inflation and corporate profits and positively correlated with movements in nominal interest rates.

Brock and LeBaron consider the impact of financial constraints on the market valuation of firms. They use a particular class of asset pricing models to analyze mean reversion in security returns and find that it is amplified by financing constraints: positive shocks to productivity affect a constrained firm's investment program more than the program of an unconstrained firm. Binding credit constraints are an important feature of mean-reverting returns in security markets.

Devereux and Schiantarelli use panel data on 689 U.K. manufacturing firms during 1969-86, to test for differences in the sensitivity of investment to the availability of internal funds for firms of different sizes and ages. They find that lagged measures of firm cash flow have an important effect on investment, holding constant investment opportunities (as measured by q); this effect is present for all sizes of firms. Devereux and Schiantarelli find that cash flow effects are particularly important for younger, smaller firms, perhaps because of information problems. They note that the cash flow effects for large firms could reflect their more diversified ownership structure and greater associated agency costs of finance.

Reiss analyzes investment behavior over the past decade for firms in oil and gas extraction. The large fluctuations in oil and gas prices led to significant changes both in investment opportunities and in the value of firms' net worth (as measured by the value of oil and gas reserves in place). Fluctuations in capital spending in the industry over this period were much more pronounced than in the economy as a whole. Reiss finds that during the 1986 downturn, shortages in internal finance accentuated declines in investment spending. He also finds that smaller producers experience relatively greater fluctuations in internal finance, and hence investment. A firm's liquidity position also affects its positions regarding ownership of wells. Smaller firms, and firms with less internal finance, hold significantly smaller interests in each well that they drill.

Meyer and Strong ask whether firms with larger "free" cash flows exhibit different investment behavior from other firms and whether these differences in investment behavior might lead to poorer or better financial performance. They consider investment decisions in 34 large paper companies from 1971 to 1986. The paper industry experienced substantial fluctuations in operating performance during that time, and has undergone considerable restructuring. Meyer and Strong confirm that discretionary investment is influenced by movements in residual funds. Moreover, links between discretionary investment and shareholder returns are consistent with an agency-cost interpretation: higher discretionary expenditures depress shareholder returns.

Gale considers the efficiency costs generated by using collateral as a sorting device when it is worth less to lenders than to borrowers. In equilibrium, relatively high-risk borrowers choose a contract with a high interest rate and low collateral requirement; low-risk borrowers choose to put up substantial collateral in exchange for a lower interest rate. As long as all borrowers have projects whose gross returns are greater than their social opportunity cost, government intervention can decrease the efficiency loss created by the use of collateral. Subsidies to unrationed borrowers will reduce the extent of rationing in the whole sector and will increase efficiency. On the other hand, interventions that target borrowers who are denied loans in private credit markets can raise the extent of rationing and reduce efficiency.

MacKie-Mason documents trends and patterns in incremental sources of financial capital at the industry and aggregate level and analyzes a large sample of incremental corporate financial decisions. He distinguishes between debt or equity financing and between privately or publicly marketed sources. Using data drawn from SEC-registered offerings, matched with COMPUSTAT data on firm characteristics, MacKie-Mason finds that problems of asymmetric information are an important determinant of financing choices. That is, firms are concerned with who provides their financing and not just with the standard factors thought to influence the mix of "debt" and "equity" finance.

In his overview of financing patterns in the United States, United Kingdom, Japan, Italy, Germany, France, Finland, and Canada, Mayer describes some common trends in corporate finance. Those patterns include the dominance of internal funds in financing investment, the importance of bank finance as a source of external funds, and systematic variations in financing patterns across firms of various sizes. Mayer believes these common factors support recent models linking corporate finance to corporate control. The particular link he stresses is the claim that outside investors can make in the event of a default by insiders. In particular, assets specific to their current employment will be difficult to finance externally, and the use of external finance will be related negatively to the cost of organizing external control.

Korajczyk, Lucas, and McDonald note that stock prices increase just prior to an equity issue and then drop just after the issue. They assume that managers--who act in the interest of existing shareholders--have private information about the firm's true value. Korajczyk, Lucas, and McDonald find that price increases occur prior to secondary issues (large block sales by existing equity holders) that reveal information but have nothing to do with additions to the firm's capital. On the other hand, firms that issue equity experience a rise in Tobin's q prior to the issue and a subsequent fall: a pattern consistent with firms' issuing equity to finance growth opportunities.

In the early 1980s, Japan eased restrictions on issuing bonds abroad, and for the first time permitted the issuance of noncollateralized bonds in domestic securities markets. Firm's reliance on banks for debt finance diminished substantially during this period. Hoshi, Kashyap, and Scharfstein compare firms that decreased their reliance on main bank finance (seeking finance instead from domestic and foreign bond markets) with firms that retained their bank ties. For the latter group, investment remained insensitive to movements in firm liquidity (holding constant investment opportunities) before and after banking deregulation. For the former, investment spending became more sensitive to fluctuations in firm liquidity.

Pound and Zeckhauser outline the potential impact of large shareholders on insiders' incentives and the flow of information. They then use cross-sectional data on firms to test for systematic variation in performance among firms with large shareholders (after controlling for industry differences). Pound and Zeckhauser classify industries according to whether capital and investments are highly firm-specific. When assets are specific to the management, it is more difficult for large shareholders (acting as monitors) to improve performance. They find that earnings-price ratios (their measure of performance) are significantly lower for firms with large shareholders in industries in which assets are less specific and monitoring is easier. There is no comparable "large shareholder" effect for firms in industries in which assets are firm-specific.

Also attending were: Carliss Y. Baldwin and Benjamin M. Friedman, NBER and Harvard University; Ben S. Bernanke, NBER and Princeton University; David Bizer, Johns Hopkins University; Charles W. Calomiris, Northwestern University; Geoffrey Carliner, NBER; Andrew W. Lo and James M. Poterba, NBER and MIT; Frederic S. Mishkin, NBER and Columbia University; Bruce C. Petersen, Federal Reserve Bank of Chicago; Terry Vaughn, MIT Press; Mark A. Wolfson, Stanford University; and Stephen P. Zeldes, NBER and University of Pennsylvania.

The conference papers and discussions are expected to be published by the University of Chicago Press. The availability of the volume will be announced in the NBER Reporter.
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Title Annotation:conference
Publication:NBER Reporter
Date:Sep 22, 1989
Previous Article:Third quarter 1989.
Next Article:International Seminar on Macroeconomics.

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