Comovement in Investment (A. Knyazeva, D. Knyazeva, R. Morck, B. Yeung) EFM Symposium - 2009 Comovement

Overview Motivation and background The argument Data and results Conclusions and future work Comovement

Background: related work Herding Return comovement. Morck, Yeung, & Yu 2000 Distortions in firm investment: low sensitivity to value added, high sensitivity to cash flow; low risk Law and finance: investor and property rights protection affects financial development, ownership concentration, corporate valuation, cash and dividend policies. LLSV. Comovement

This paper Is there comovement in firm investments? After controlling for firm similarities and economic characteristics, correlation in investment decisions is due a common subset of information. Can we explain it by agency, information asymmetry? Are there gains from information acquisition, is CI distortionary? Comovement

The “how”: information acquisition Firms can “discover” (acquire) value-relevant information about investment projects Such information is private and costly, so firms can instead use less accurate, public information Tradeoff  endogenous information acquisition Investments based on similar information result in the observed higher comovement (CI) Several reasons for suboptimally low information acquisition and high CI Comovement

“Why”: Agency Investors delegate investment and information acquisition decisions to managers Information acquisition effort  agency conflict (The manager bears the cost but does not absorb the full benefit of higher firm value) H1: Stronger governance  Less Comovement Alternative argument: entrenched managers face fewer career concerns (Scharfstein and Stein 1990, Stein 2003) / relative performance evaluation (Maug and Naik 1996)  herd less Comovement

“Why”: information asymmetry Information asymmetry: private investment information is not verifiable. In anticipation of added scrutiny, higher cost of capital, managers invest based on public information  comovement. Disclosure standards and analyst forecasts can mitigate the information asymmetry H2: Lower information asymmetry  Less Comovement Comovement

“Why”: Property rights Expropriation of private property rights: rent-seeking/threat of expropriation by the public sector  lower cash flows, lower gains to information acquisition  more comovement H3: Better Property Rights  Less Comovement Comovement

Other determinants of comovement Ownership concentration (?) Similar growth and investment opportunities (+) Correlated cash flows * financial constraint (+) Dependence on external equity markets (-/?) Common shocks (high-tech firms) (+) Low asset specificity (many tangible assets) (+) Industry concentration (product markets) (+) Macro level: volatility (+), weak financial development (+); income (-) Comovement

Performance effects of comovement C.p., underuse of private information leads to less optimal allocation of capital to investment projects (accept NPV-, forgo NPV+ projects) and to forgoing firm-specific improvements in investment technology The result is decreased performance and lower productivity growth (at the country level) H4: High comovement  Lower performance Comovement

Data and variables Compustat Global Industrial / Global Issues for data on firm characteristics for 1994-2004 In firm-level analyses, use S&P’s Transparency and Disclosure data (1998-2002) Exclude financials and utilities, obs. with missing data, and country-years with fewer than 10 obs. Firm-level propensity to comove with the industry investment trend; comovement index constructed similarly to Morck, Yeung, and Yu 2000 TFP growth - similarly to John et al. 2007 Performance regressions: 3-year MA of lags, IV Comovement

Determinants of CI: Industry, Intl (Table 2) Comovement

Determinants of CI: Firm-level, Intl (Table 3) Comovement

Determinants of CI: Firm-level, US (Table 5) Comovement

Performance effects of CI: Firm & Industry, US (Table 7) Comovement

Conclusions and future work As with investors and fund managers, we find that some firms mimic each other’s investment decisions Less stringent monitoring of the management lowers costly information acquisition effort and leads to excessive reliance on public investment information Firms faced with high information asymmetry similarly conform to the common trend Legal environment features such as weak shareholder and property rights are also associated with higher comovement in investment Comovement

Conclusions and future work (cont) Tested other explanations for differences in CI, including similar investment opportunities (+), common shocks (+), low asset specificity (+), financial constraints, concentrated ownership Bottom-line effects: distortionary effect of high comovement on performance and growth, c.p. Potential extension: differences across economic cycles; Implication: can explain return comovement and inefficient investment allocation Comovement