Product Characteristics, Competition and Dividends by Hoberg, Phillips, and Prabhala University of Maryland Discussion by Gustavo Grullon Rice University

Motivation l A large theoretical literature examines the relation between corporate financial decisions and product market behavior. l Brander and Lewis (AER 1986) l Bolton and Scharfstein (AER 1990) l Most empirical studies focus on the interaction between capital structure and product market behavior. l Chevalier (AER 1995) l Phillips (JFE 1995)

Motivation l Recent studies examine the effects of product market competition on cash holdings and payout policy. l Haushalter, Klasa, and Maxwell (JFE 2007): Find positive correlation between cash holdings and concentration measures. l Evidence of predation risk l Grullon and Michaely (2008): Find negative correlation between payout ratios and concentration measures. l Evidence supporting agency theory (Outcome model, LLSV (JF 2000))

This Paper l This paper further contributes to this literature by examining the interaction between product market behavior and corporate payout policy. l Using text-based analysis of product descriptions in financial statements, the authors create several measures of product market behavior: l Product Fluidity or Instability l Product Market Competition l Product Customer Type

Main Results l Firms with more product fluidity have a lower propensity to distribute cash. l Product fluidity is a forward looking measure of product market risk. l More risk  less dividends. l Firms with more unique products and in protected markets have a higher propensity to distribute cash. l These firms face less product market risk. l Less risk  More dividends. l Firms that sell their products to other firms are more likely to pay dividends, and prefer dividends over share repurchases. l Interpretation: Dividends signal stability - this attracts business clients. l Less risk  More dividends.

General Impression l This paper examines a very interesting and important issue in corporate finance. l I really like: (1) the new methodological approach to measure product market behavior. (2) the strong and consistent findings that firms with lower risk pay more dividends l I have some suggestions about: l The interpretation of the empirical results l The design of the empirical tests l The measures of competition l Causality

Comment # 1 l The main takeaway from this paper is that product market risk affects corporate payout policy. l The new measures of product market behavior, to some extent proxy for risk (a good thing, but should be recognized explicitly). l Alternative explanations: l Investment Opportunities and Growth Options l Unobservable industry effects

Investment Opportunities l Measures of product market behavior could be proxying for investment opportunities. l For example, firms with more product fluidity have better investment opportunities and growth options (e.g., Apple). l Control variables may not be completely capturing investment opportunities. l Market-to-book: Measurement errors, marginal vs. average q l Sales growth: Backward-looking measure

Industry Effects l Industry fixed effects are important determinants of corporate payout policy. l Industry fixed effects may be capturing unobservable factors unrelated to product market risk (e.g., growth options). l Table 3 show that most firms with high product market fluidity are pharmaceuticals and bio-tech firms. l Is it fair to compare a bio-tech firm (Amgen) to a firm that sells corporate uniforms (Cintas)? l Include industry dummies (two-digit SIC) in the regressions.

Comment # 2 l This paper focuses on the effects of product market behavior on the propensity to pay dividends and repurchase shares. l Limitation: It assumes that a firm with a dividend yield of 0.001% is similar to a firm with a dividend yield of 5%. l Many firms pay very low dividends just to comply with the “prudent man” rules. l Big difference in term of institutional holdings (between low div and high div firms—see Grinstein and Michaely (JF 2005) l Big differences in other characteristics. l The paper should primarily focus on the effects of product market behavior on payout levels. l Measures: Dividend yield, dividends over assets, etc. l Use Tobit regressions

Comment # 3 l Table 2 shows that the localized measure of concentration (HHI) is l Positively correlated with risk l Negatively correlated with size l Uncorrelated with profitability l Measures of product of market competition may be proxying for something else. l Similar to the findings using Compustat measures of concentration (Ali, Klasa, and Yeung (RFS 2009)). l May be capturing declining industries l May be capturing the effect of ignoring private firms

Comment # 4 l Some of the relations documented in the paper could be endogenous. ↑Payouts → ↑Business customers ↑Business customers → ↑ Payouts l Need identification strategy to infer causality.

Other Issues l Use the logarithm of total risk as a control variable. l Relation between dividends and risk could be nonlinear. l Examine the effects of large changes in your measures of product market behavior on payout policy. l The matched sample analysis (Table 6) excludes ROA as a control variable. Not clear why. l Do you winsorize the data to control for outliers?

Conclusion l The paper examines an interesting and important issue. l Using text-based analysis to measure product market behavior is a very clever idea. l However, the authors need to do more to convince the reader that the results are consistent with their main hypothesis.