Investment and the weighted average cost of capital: new firm-level evidence for France J. Carluccio 1 C. Mazet-Sonilhac 1,2 J.S. Mésonnier 1 1 Banque de France 2 Sciences Po Paris Work in progress. This version: April 18, 2018 Opinions expressed are those of the authors and do not necessarily reflect the views of the Banque de France or the Eurosystem
Motivation Persistent slow growth environment in developed economies post 2008, notably in the euro area. Corporate investment deficit" often seen as a major cause. low investment rate in France until 2014, recent upsurge, but maybe partly fueled by temporary accelerated depreciation scheme (2015-2017) Investment:1995-2016 Reasons? expected demand (and heightened uncertainty), competition, short-termism... What about financial factors? Too high cost of capital and hurdle rates in spite of lowered cost of debt (very accomodative MP)? WACC: 2006-2018 cf. Villeroy de Galhau report (2016)
Main findings We document the link between corporate investment and Tobin s Q components (among which the real WACC) using French micro data for non-financial groups over 2003-2015. NB: Listed + Non-listed, Large + Small corporates Main findings: i. Negative correlation of investment with WACC. ii. using cost of debt instead of WACC leads to biased assessment of role of cost of capital for corporate investment iii. Lower coefficient after 2008. iv. Competition matters at firm-level (in OLS regressions only), not uncertainty.
Related Literature WACC and cost of equity matter for investment when properly measured: Franck & Shen (2016), Melolinna, Miller & Tatomir (2017) Investment-less growth in the US since 2000s reflects short-termism and lower competition: Philippon & Gutierrez (2017) Share buybacks explain disconnect between Q, net funding and investment in the US since late 90s: Lee, Shin, Stulz (2016) High COE and low interest rates, a cause of carry trade and share buybacks: Blundell-Wignall & Roulet (2013), Acharya & Plantin (2017) Net lending (saving investment) by US NFCs, but not in France since 2000s: Gruber & Kamin (2015)
Empirical model Regressions motivated by a simple Q-model of investment, following Franck & Shen (JFE, 2016). Firm chooses I to max NPV, constrained by K accumulation and K-adjustment cost I t K = 1 t φ + q t φ Using symplifying assumptions (Abel & Blanchard, 1986): I it K it 1 = β 0 + β 1 Profits it K it 1 + β 2 (L it (1 τ it ) CoD it +(1 L it ) CoE it ) }{{} WACC it + θx it + δ t + γ f + ɛ it with leverage L it = Gross Debt / [Gross Debt + Equity].
Data Estimating sample Consolidated BS data for some 7,510 French corporate groups (hereafter: firms) from BdF s FIBEN Groupes database over the period 1990-2015 Stock market information for 600 listed corporates (Datastream, BdF-DE) = sector-specific measure of COE (DS industries matched into NAF-2 A38 sectors) Cleaning 2,482 corporate groups over 2003-2015 ( 200 are listed). Average cross-section: 1,100 corporate groups (Smaller: 600 / Larger: 1400). Average # consecutive years per group: 5,7. Cleaning details Cleaning GMM
Variable construction Firm-level measure of the WACC: Sector-level (NAF-2/A88) measures of nominal COE using DDM H-model for listed groups in each sector. COE details Firm-level apparent cost of debt, leverage and tax rate. Deflator of COE, COD, WACC: core HICP. Firm controls: size, investment into financial assets, M&A dummy. Sector-level controls (A38): Herfindahl index of firms sales (using FIBEN database for legal entities) Competition Uncertainty (sector-year dispersion in ROA) Uncertainty
Micro Data: descriptive statistics Nb.Obs. Mean Std.Dev. p10 p25 Median p75 p90 Investment rate (I/ FA 1) 9991 0.13 0.13 0.03 0.05 0.09 0.17 0.28 Net Investment rate (NI/ FA 1) 9991 0.05 0.17-0.06-0.02 0.02 0.08 0.20 Depreciation rate δ (DEP/ FA 1) 9991 0.11 0.10 0.03 0.06 0.08 0.13 0.20 Cash-flows to Fixed Assets (OIBDP/ FA 1 ) 9991 0.32 0.41 0.07 0.13 0.21 0.35 0.61 Nominal Cost of Debt (CoD) 9991 0.04 0.04 0.02 0.03 0.04 0.05 0.07 Nominal Cost of Equity 9991 0.08 0.03 0.05 0.06 0.07 0.09 0.12 Nominal WACC 9991 0.06 0.02 0.04 0.04 0.05 0.06 0.08 Real Cost of Debt 9991 0.03 0.04 0.00 0.01 0.02 0.04 0.05 Real Cost of Equity (CoE) 9991 0.06 0.03 0.03 0.05 0.06 0.08 0.10 Real CoD * (1 - τ) 9991 0.02 0.03 0.00 0.01 0.02 0.03 0.04 Real WACC 9991 0.04 0.02 0.02 0.03 0.04 0.05 0.07 Tax rate τ (Apparent, sector level) 9991 0.31 0.13 0.23 0.28 0.31 0.34 0.37 Leverage (Debt / Equity + Debt) 9991 0.42 0.21 0.13 0.26 0.43 0.58 0.70 Firm size (TA, in M euros) 9991 924.85 9981.47 20.95 33.73 63.92 160.87 437.52 Investment in financial assets (IFI /FA 1) 9991 0.00 0.01-0.00 0.00 0.00 0.00 0.00 Note. Sample of 2,482 corporate groups (firms) over 2003-2015. Gross investment: acquisitions minus cession of fixed assets, net investment: gross investment minus depreciation and amortization, Cashflows: Operating Income Before Depreciation (EBITDA), the (firm-specific) implied cost of debt: interest payments normalized by gross long-term debt and leverage: D/(D+E). CoE: computed at the sector level for 49 sectors with a DDM H-Model. Nominal returns are deflated using the french core HICP Real and nominal WACC Real and nominal CoD / CoE External Validity
Investment and the WACC: baseline results OLS GMM - 2SLS GMM - LIML (1) (2) (3) (4) (5) (6) (7) (8) Cash-flows (OIBDP/FA) 0.086 0.079 0.079 0.077 0.084 0.247 0.223 0.249 (0.008) (0.008) (0.008) (0.008) (0.010) (0.053) (0.051) (0.052) Real WACC -0.789-0.821-0.816-0.771-3.645-3.674 (0.110) (0.112) (0.112) (0.135) (0.906) (0.899) Real CoD * (1 - τ) -0.354-0.372 (0.063) (0.107) Firm FE Yes Yes Yes Yes Yes Yes Yes Yes Year FE Yes Yes Yes Yes Yes Yes Yes Yes Firm controls No Yes Yes Yes Yes Yes Yes Yes Sector controls No No Yes Yes Yes Yes Yes Yes Observations 9,990 9,990 9,990 9,990 8,121 8,121 8,121 8,121 Kleibergen-Paap LM stat. p-val. 0.00 0.00 0.00 Kleibergen-Paap Wald F stat. 12.32 9.17 12.32 Hansen J stat. p-val. 0.27 0.20 0.27 Note. OLS regressions. Sample period: 2003-2015. Unbalanced panel of all firms in our sample. Dependent variable: gross fixed capital investment rate (I /FA 1 ). Firm controls: depreciation over lagged fixed assets, log size, a dummy for M&A activity and purchases of financial assets. Sector controls: competition and uncertainty. Standard errors in parentheses are clustered at the firm level. For GMM: excluded instruments are the first lag of profitability and the contemporary and lagged variation y-o-y of the cost of debt. Kleibergen-Paap F-stat to be compared with critical values from Stock & Yogo (2005). Is the Q-model of I vindicated? Do competition and uncertainty matter?
Cost of capital matters less post-2008 (and profits/demand more)... OLS GMM - 2SLS GMM - LIML (1) (2) (3) (4) (5) (6) Cash-flows (OIBDP/FA) 0.079 0.067 0.247 0.205 0.249 0.210 (0.008) (0.008) (0.053) (0.046) (0.052) (0.045) Post-2008 x cash-flows 0.020 0.080 0.082 (0.009) (0.029) (0.028) Real WACC -0.816-1.479-3.645-5.723-3.674-5.782 (0.112) (0.235) (0.906) (2.618) (0.899) (2.586) Post-2008 x real WACC 0.795 2.410 2.396 (0.226) (2.679) (2.643) Firm FE Yes Yes Yes Yes Yes Yes Year FE Yes Yes Yes Yes Yes Yes Firm controls Yes Yes Yes Yes Yes Yes Sector controls Yes Yes Yes Yes Yes Yes Observations 9,990 9,990 8,121 8,121 8,121 8,121 Kleibergen-Paap LM stat. p-val. 0.00 0.00 0.00 0.00 Kleibergen-Paap Wald F stat. 12.32 2.03 12.32 2.03 Hansen J stat. p-val. 0.27 0.20 0.27 0.19 Note. OLS regressions. Sample period: 2005-2015. Unbalanced panel of all firms in our sample. Dependent variable: gross fixed capital investment rate (I /FA 1 ). SMEs: staff < 250 and sales < 50 M euros (or assets < 43 M euros). Mid-Size: staff < 5,000 and sales < 1.5 bn euros (or assets < 2 bn euros). Large firms: above these thresholds. Firm controls: depreciation over lagged fixed assets, log size and a dummy for M&A activity and purchases of financial assets. Sector controls: competition and uncertainty. Standard errors in parentheses are clustered at the firm level. For GMM: excluded instruments are the first lag of profitability and the contemporary and lagged variation y-o-y of the cost of debt + those three Corporate instruments Investment interacted and WACC with a post-crisis dummy; Kleibergen-Paap F-stat to be compared with critical
Conclusion We document the role of the WACC in the subdued level of corporate investment in France since 2008 for a large sample of mostly unlisted corporate groups. Our results confirm that relatively high cost of capital has weighed down on investment into fixed assets. Firm-specific apparent interest rate on debt only poor measure of relevant total cost of capital Post 2008: weakened role of cost of capital Increased role for low margins and cash flows during the post-2008 slump? No clear role for competition earlier findings for the US Further research: collect genuine info on hurdle rates and premia? Indeed, the latter may be large (5 8%) according to recent US and UK surveys (Jagannathan et al., JFE 2016, Melolinna et al., BoE 2017).
Appendix
Subdued corporate investment in France since 2008? 110 Two metrics of the gross investment rate (2008=100) 105 100 GI/VA in 2016 = 24% 95 90 85 GI/FA in 2016 = 11,7% 80 1985 1990 1995 2000 2005 2010 2015 GI/VA GI/FA Note. Source: INSEE. GI = Gross fixed capital formation of NFCs. VA = Gross VA of NFCs. FA = Net fixed capital of NFCs. Back
Does the high CoE explain subdued investment? Note. Cost of equity for large listed French NFCs as in Mazet-Sonilhac and Mésonnier (2016). Effect of share buybacks not included. Average corporate bond rate from Gilchrist and Mojon (2016). Interest rate on corporate loans: interest rate on new MFI loans to French NFCs above 1 M euros. Back
Distribution of estimated WACC Figure 1: WACC at sector-level (Real vs Nominal) Back
Real WACC, CoE and CoD in our sample Figure 2: Median per year of real WACC, COE and COD (firm-level) Back
Sample validation: micro vs macro Figure 3: Gross investment measured by macro and micro data Note. Gross investment rate (I/FA 1 ): ratio of gross fixed capital formation to fixed assets. French corporates over the period 2005-2015. Macro data (INSEE national accounts) and our sample of micro data (BdF s FIBEN Groupes). Back
Data cleaning Drop farm, mining, financial services, real estate Drop years before 2003: not enough groups in cross-section Drop observations w/ missing or negative values of FA, Inv, TA, Equity Drop observations in top 1% / bottom 1% of investment rate and CoE. Drop firms w/ investment rates (corrected for year fixed effects) below 10th percentile. Impose at least 3 consecutive years 2,482 corporate groups over 2003-2015 ( 200 are listed). Average cross-section: 1, 100 corporate groups (Smaller: 600 / Larger: 1400). Average # consecutive years per group: 5,7. Cleaning details Back
Data Cleaning for GMM We impose at least 4 years in a row to use lags as IV Cleaning 1,850 corporate groups over 2003-2015 ( 200 are listed). Average cross-section: 1, 100 corporate groups (Smaller: 450 / Larger: 1300). Average # consecutive years per group: 6.4. Back
Data: Cost of Equity We construct (NAF-2/A38) sector-level measures of the (real) cost of equity to compute the (real) WACC (deflator: core HICP). Nominal COE estimated based on a standard Dividend Discount Model (H-Model, Fuller and Shia, 1983): CoE t = D t P t 1 ((1 +g LT ) + H 2 ((g ST ) g LT )) +g LT DY : 2-digit sector average of in-sample listed firms DY (A38) g LT : nominal GDP growth, 10 years forecast (source: SPF) g ST : Datastream sector-level expected profit growth, 3-5 years forecast (source: I/B/E/S), mapped into NACE-2 sectors. H : 8 years Back
Is the Q-model of I vindicated? A preliminary test based on listed firms OLS GMM - 2SLS GMM - LIML (1) (2) (3) (4) (5) (6) Tobin s Q 0.027 0.034 (0.016) (0.022) Cash-flows (OIBDP/FA) 0.089 0.085 0.152 0.152 (0.015) (0.014) (0.032) (0.032) Real WACC -0.625-0.540-1.477-1.477 (0.167) (0.245) (1.376) (1.362) Firm FE Yes Yes Yes Yes Yes Yes Year FE Yes Yes No Yes Yes Yes Firm controls No Yes Yes Yes Yes Yes Observations 1,475 1,145 1,145 1,145 900 900 Kleibergen-Paap LM stat. p-val. 0.00 0.00 Kleibergen-Paap Wald F stat. 4.17 4.17 Hansen J stat. p-val. 0.92 0.92 Note. OLS regressions. Sample period: 2003-2015. Unbalanced panel of listed corporate groups only. Tobin s Q is [Total assets + market value of equity - book value of equity] / total assets. Firm controls: depreciation over lagged fixed assets, log size, a dummy for M&A activity and purchases of financial assets. Standard errors in parentheses are clustered at the firm level. For GMM: excluded instruments are the first lag of profitability and the contemporary and lagged variation y-o-y of the cost of debt. Kleibergen-Paap F-stat to be compared with critical values from Stock & Yogo (2005). Back
Do competition and uncertainty matter? OLS GMM - 2SLS (1) (2) (3) (4) (5) (6) Cash-flows (OIBDP/FA) 0.079 0.079 0.079 0.247 0.247 0.246 (0.008) (0.008) (0.008) (0.053) (0.053) (0.053) Real WACC -0.822-0.820-0.822-3.638-3.633-3.632 (0.112) (0.112) (0.112) (0.904) (0.903) (0.903) Concentration -0.129-0.128 0.080 0.080 (0.072) (0.072) (0.108) (0.109) Uncertainty 0.010 0.010-0.020-0.020 (0.018) (0.018) (0.022) (0.022) Firm FE Yes Yes Yes Yes Yes Yes Year FE Yes Yes Yes Yes Yes Yes Firm controls Yes Yes Yes Yes Yes Yes Sector controls Yes Yes Yes Yes Yes Yes Observations 9,990 9,990 9,990 8,121 8,121 8,121 Kleibergen-Paap LM stat. p-val. 0.00 0.00 0.00 Kleibergen-Paap Wald F stat. 12.34 12.33 12.33 Hansen J stat. p-val. 0.27 0.26 0.26 Note. OLS regressions. Sample period: 2005-2015. Unbalanced panel of all firms in our sample. Dependent variable: gross fixed capital investment rate (I /FA 1 ). Firm controls: depreciation over lagged fixed assets, log size, a dummy for M&A activity and purchases of financial assets. Sector controls: competition and uncertainty. Standard errors in parentheses are clustered at the firm level. For GMM: excluded instruments are the first lag of profitability and the contemporary and lagged variation y-o-y of the cost of debt. Kleibergen-Paap F-stat to be compared with critical values from Stock & Yogo (2005). Back
Cost of equity Figure 4: Cost of equity at sector-level (Real vs Nominal) Back
Cost of Debt Figure 5: Cost of debt at sector-level (Real vs Nominal) Back
Competition Figure 6: Firm concentration at A38 sector-level (Sector Herfinhdal) Back
Uncertainty Figure 7: Uncertainty at A38 sector-level Back