Investment and Institutions Stijn Claessens, Kenichi Ueda, and Yishay Yafeh International Monetary Fund and University of Amsterdam, International Monetary Fund, and Hebrew University 16 th Dubrovnik Economic Conference, June 24, 2010 The views expressed in this paper are those of the authors and should not be attributed to the International Monetary Fund, its Executive Board or its management.
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Investment and Institutions Stijn Claessens, Kenichi Ueda, and Yishay Yafeh International Monetary Fund and University of Amsterdam, International Monetary.
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Investment and Institutions
Stijn Claessens, Kenichi Ueda, and Yishay YafehInternational Monetary Fund and University of Amsterdam, International Monetary Fund, andHebrew University
16th Dubrovnik Economic Conference, June 24, 2010
The views expressed in this paper are those of the authors and should not be attributed to the International Monetary Fund, its Executive Board or its management.
2
MotivationMotivation
Capital is not always allocated efficiently (Hsieh and
Klenow, 2009; Abiad, Oomes, and Ueda, 2008)
TFP is the most important factor for growth.
Does the institutional environment affect the cross-
country differences in investment efficiency, and, if so,
which institutions and how?
How should we judge the cross-country differences in
investment efficiency?
3
Our ConjectureOur Conjecture
Tobin’s Q is a measure of investment
efficiency.
Tobin’s Q should be 1 in a perfect world.
If not, it should approach 1 over time.
This adjustment may be slower in countries
with worse institutions.
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Main ResultsMain Results
Good institutions can affect the investment
efficiency through two channels:
Lower required return allows a larger adjustment
in Q (from above) as the required capital gain (given
current profits) is less.
Less financial frictions create less divergence of
Tobin’s Q from its steady state to begin with,
implying slower adjustment in Q.
5
Main ResultsMain Results
Thus, Implication of efficient investment on overall
adjustment speed of Q is theoretically unclear.
We estimate the institutional effects through each of
two channels separately using a canonical model of
investment.
Regression results support beneficial effects of good
corporate governance, operating through both
channels, and high general institutional quality,
operating through financial friction channel.
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Literature: Finance-Efficiency LinkLiterature: Finance-Efficiency Link
Efficiency of allocating capital across sectors has
been estimated using a variety of measures
GDP growth or TFP growth (e.g., Beck, Loayza, and
Levine, 2000; De Nicolo, Laeven, and Ueda, 2008)
Industry growth (e.g., Rajan and Zingales, 1998, and
Wurgler, 2000).
Dispersion of firm-level productivity (e.g., Hsieh and
Klenow, 2009, and Abiad, Oomes, and Ueda, 2008).
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Literature: Tobin’s QLiterature: Tobin’s Q
Tobin's Q measures efficiency in the use of capital (Tobin, 1969)
Speed of investment adjustment relates to Q (Mussa, 1977).
Because of adjustment costs, investment and Tobin’s Q relate in
non-linear ways (Abel and Eberly, 1994) without financial
frictions.
With financial frictions, the sign of cash-flow sensitivity of
investment becomes difficult to predict (Gomes, 2000).
Moreover, market imperfections and varying discount factors
affect movements in Q (Abel and Eberly, 2008).
(Measurement error issues are discussed later.)
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Literature: Measures of SystemsLiterature: Measures of Systems
Many measures have been developed/collected for
institutional and financial development (e.g.,
Demirguc-Kunt and Levine, 2001, Morck et al, 2000,
La Porta et al., 2008).
These allow comparisons of financial and governance
systems around the world.
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ModelModel
Develop a canonical model of Tobin’s Q with both adjustment cost of investment and financial frictions (Abel and Blanchard (1986), Abel and Eberly (1994, 2008), Gomes (2000), and Hennessy et al. (2007)).
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TimingTiming
Given K– and revealed current productivity ε at the
beginning of the current period:
Investment I is determined
Adjustment costs ϕ are wasted on investment
New capital K is formed and usable immediately
Using K, goods are produced with productivity ε
Fees λ paid for external financing (over-the-period)
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ModelModel
( , ) ( , )t t t t t t tK f K L w L
1(1 ) tt tIK K
1 1, , ( , ) (1 ) ( , )t t t t tt t t t tB K K I K K K K ò
max , ) ( , ; , , )
( , ; ,
1( ; ) (
1
) ( ;, )
KI K X W
B K X
V
K
r
V
K K
EW
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TimingTiming
First-order condition
Envelope condition
Combined together and use
1 1 1 1 11 2 2 E V
1 1 1(1 )(1 )r V
1Q V
1 1 2 2(1 (1 ))E Q r Q
KUeda
In addition to financial friction lambda, the required return r may be affected by institutions and macroeconomic fundamentals.
KUeda
Given financial fricions investment is nonlinearly affected by current and next period Q. But we don't use investment data to estimate frictions.
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Adjustment Speed of QAdjustment Speed of Q
Adjustment in Q depends on required return and frictions
Lower required return allows a larger adjustment in Q
(from above) as the required capital gain (given current
profits) is less.
Less financial frictions creates less divergence of Tobin’s Q
from its steady state to begin with, implying slower
Only corporate governance significantly lowers the required return (in many specifications)
One std dev change in anti-director rights (1.3), mean Q goes down by 0.2 for average firm with Q=3.
Product market competition increases required return (though not so often)
Firm age very slightly increase required return.(As a firm becomes older and bigger, its returns comove more with market portfolio, reducing insurance premium.)
Other factors do not have robust effects.
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Findings on Internal Fin Frictions (2)-(4)
Slope and curvature of costs associated with the size of
external finance is little affected by any institutional
factors.
Better general institutional quality sometimes worsen the
curvature but not robust.
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Findings on Internal Fin Frictions (2)-(4)
Extra costs that small firms need to pay (small-firm
premium) are less in country with better corporate
governance and general institutional quality (column 3).
One std dev improvements in CG lowers the premium by
about 3 cents per dollar asset.
One std dev improvements in institutional quality lowers
premium by about 4 cents per dollar assets.
Other factors do not have robust effects on
financial frictions.
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Real Adj. Cost of Investment
Real adjustment cost of investment are not affected by X.
How about institutional factors W?
Entrenchment of managers under private information (Myers and Majluf
(1984) and workers’ sabotage (Parente and Prescott, 2000)
We find:
Better corporate governance and general institutional quality reduce
technological/managerial diseconomy of scale.
But somewhat offset by increased curvature.
Without coeff on investment, overall effect is unidentified.
Other institutional factors do not have significant effects.
All effects on financial frictions and required returns are unchanged.