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The Cross-Section of Labor Leverage and Equity Returns*
January 2017
Working Paper Number:
CES-17-70
We study labor-induced operating leverage. Theoretically, we show that if labor markets are frictionless, two sufficient conditions for the existence of labor leverage are (a) relatively smooth wages and (b) a capital-labor elasticity of substitution strictly less than one. Our model provides theoretical support for the use of labor share'the ratio of labor expenses to value added'as a measure of labor leverage. We provide evidence for conditions (a) and (b), and we demonstrate the economic significance of labor leverage: High labor-share firms have operating profits that are more sensitive to economic shocks and have higher expected returns.
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Are firm-level idiosyncratic shocks important for U.S. aggregate volatility?
January 2017
Working Paper Number:
CES-17-23
This paper quantitatively assesses whether firm-specific shocks can drive the U.S. business cycle. Firm-specific shocks to the largest firms can directly contribute to aggregate fluctuations whenever the firm size distribution is fat-tailed giving rise to the granular hypothesis. I use a novel, comprehensive data set compiled from administrative sources that contains the universe of firms and trade transactions, and find that the granular hypothesis accounts at most for 16 percent of the variation in aggregate sales growth. This is about half of that found by previous studies that imposed Gibrat's law where all firms are equally volatile regardless of their size. Using the full distribution of growth rates among U.S. firms, I find robust evidence of a negative relationship between firm-level volatility and size, i.e. the size-variance relationship. The largest firms (whose shocks drive granularity) are the least volatile under the size-variance relationship, thus their influence on aggregates is mitigated. I show that by taking this relationship into account the effect of firm-specific shocks on observed macroeconomic volatility is substantially reduced. I then investigate several plausible mechanisms that could explain the negative sizevariance relationship. After empirically ruling out some of them, I suggest a 'market power' channel in which large firms face smaller price elasticities and therefore respond less to a givensized productivity shock than small firms do. I provide direct evidence for this mechanism by estimating demand elasticities among U.S. manufactures. Lastly, I construct an analytically tractable framework that is consistent with several empirical regularities related to firm size.
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Do Firms Mitigate or Magnify Capital Misallocation? Evidence from Plant-Level Data
January 2017
Working Paper Number:
CES-17-14
Almost two thirds of the cross-plant dispersion in marginal revenue products of capital occurs
across plants within the same firm rather than between firms. Even though firms allocate investment very differently across their plants, they do not equalize marginal revenue products across their plants. We reconcile these findings in a model of multi-plant firms, physical adjustment costs and credit constraints. Credit constrained multi-plant firms can utilize internal capital markets by concentrating internal funds on investment projects in only a few of their plants in a given period and rotating funds to another set of plants in the future. The resulting increase in within-firm dispersion of marginal revenue products of capital is hence not a symptom of misallocation within the firm, but rather actions taken by the firm to mitigate external credit constraints and adjustment costs of capital. Economies with multi-plant firms produce more aggregate output despite higher dispersion in marginal revenue products of capital compared to economies with single-plant firms. Because emerging economies are predominantly populated by single-plant firms, the gains from reducing their distortions to the level of developed are
larger than previously thought.
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Spinout Formation: Do Opportunities and Constraints Benefit High Capital Founders?
June 2015
Working Paper Number:
CES-15-07
We examine the role of human capital in employees' decisions to leave their parent firms andform spinouts. Using a large sample of individuals who formed spinouts in manufacturing industries between 1992 and 2005, and their co-workers who did not, we find that after controlling for age, education level, gender and alien status, individuals with higher human capital (measured as their earnings or experience) are more likely to form spinouts. We then examine the impact of industry opportunities and constraints on the propensity of high human capital individuals to form spinouts. Counterintuitively, we find that both industry constraints (measured as industry capital intensity) and opportunities (industry R&D intensity) reduce the propensity of higher human capital individuals to form spinouts. We interpret these results as being consistent with the argument that high human capital founders are more likely to choose larger, more capital-intensive projects than low human capital individuals, and thus face greater constraints. On the other side, R&D intensive industries appear to present abundant entrepreneurial opportunities, allowing low human capital individuals to identify their own opportunities thus decreasing the relative advantage of high human capital individuals.
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THE OPTION TO QUIT: THE EFFECT OF EMPLOYEE STOCK OPTIONS ON TURNOVER
January 2014
Working Paper Number:
CES-14-06
We show that in the years following a large broad-based employee stock option (BBSO) grant, employee turnover falls at the granting firm. We find evidence consistent with a causal relation by exploiting unexpected changes in the value of unvested options. A large fraction of the reduction in turnover appears to be temporary with turnover increasing in the 3rd year following the year of the adoption of the BBSO plan. We also find that the effect of BBSO plans is larger at market leaders, identified as firms with high industry-adjusted market-to-book ratios, market share or industry-adjusted profit margins, as measured at the time of the grant.
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Financial Frictions and Investment Dynamics in Multi-Plant Firms
October 2013
Working Paper Number:
CES-13-56
Using confidential Census data on U.S. manufacturing plants, we document that most of the dispersion in investment rates across plants occurs within rms instead of across firms. Between- firm dispersion is almost acyclical, but within- rm dispersion is strongly procyclical. To investigate the role of rms in the allocation of capital in the economy, we build a multi-plant model of the firm with frictions at both levels of aggregation. We show that external nancing constraints at the level of the rm can have important implications for plant-level investment dynamics. Finally, we present empirical evidence supporting the predictions of the model.
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PRODUCTIVITY, RESTRUCTURING, AND THE GAINS FROM TAKEOVERS
April 2013
Working Paper Number:
CES-13-18
This paper investigates how takeovers create value. Using plant-level data, I show that acquirers increase targets' productivity through more efficient use of capital and labor. Acquirers significantly reduce capital expenditures, wages, and employment in target plants, though output is unchanged. Acquirers improve targets'investment efficiency through better capital reallocation. Moreover, changes in productivity help explain the merging firms' announcement returns. The combined announcement returns are driven by improvements in target's productivity. Targets with greater productivity improvements receive higher premiums. These results provide some first empirical evidence on the relation between productivity and stock returns in the context of takeovers.
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The Real Effects of Hedge Fund Activism: Productivity, Risk, and Product Market Competition
July 2012
Working Paper Number:
CES-12-14
This paper studies the long-term effect of hedge fund activism on the productivity of target firms using plant-level information from the U.S. Census Bureau. A typical target firm improves its production efficiency within two years after activism, and this improvement is concentrated in industries with a high degree of product market competition. By following plants that were sold post-intervention, we also find that efficient capital redeployment is an important channel via which activists create value. Furthermore, our analyses demonstrate that measuring performance using the Compustat data is likely to lead to a downward bias because target firms experiencing greater improvement post-intervention are also more likely to disappear from the Compustat database. Finally, consistent with recent work in asset-pricing linking firm investment decisions and expected returns, we show how changes to target firms' productivity are associated with a decline in systemic risk, particularly in competitive industries.
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IPO Waves, Product Market Competition, and the Going Public Decision: Theory and Evidence
March 2012
Working Paper Number:
CES-12-07
We develop a new rationale for IPO waves based on product market considerations. Two firms, with differing productivity levels, compete in an industry with a significant probability of a positive productivity shock. Going public, though costly, not only allows a firm to raise external capital cheaply, but also enables it to grab market share from its private competitors. We solve for the decision of each firm to go public versus remain private, and the optimal timing of going public. In equilibrium, even firms with sufficient internal capital to fund their new investment may go public, driven by the possibility of their product market competitors going public. IPO waves may arise in equilibrium even in industries which do not experience a productivity shock. Our model predicts that firms going public during an IPO wave will have lower productivity and post-IPO profitability but larger cash holdings than those going public off the wave; it makes similar predictions for firms going public later versus earlier in an IPO wave. We empirically test and find support for these predictions.
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Information and Industry Dynamics
August 2010
Working Paper Number:
CES-10-16R
This paper develops a dynamic industry model in which firms compete to acquire customers over time by disseminating information about themselves under the presence of random shocks to their efficiency. The properties of the model's stationary equilibrium are related to empirical regularities on firm and industry dynamics. As an application of the model, the effects of a decline in the cost of information dissemination on firm and industry dynamics are explored.
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