Presence Of Adjustment Costs Research Articles

Household Finance in Developing Countries: Evidence from India

This paper studies how adjustment costs in real estate investments affect portfolio choices of developing economy households. Using novel panel data on Indian households, we document that while most households hold outstanding investments in real estate, the majority of them participated exclusively in financial assets during the five year survey period. We explain these stylized facts by identifying how households allocate their marginal income across various assets. Using local rainfall shocks as a source exogenous variation in household incomes, we empirically establish the presence of adjustment costs in real estate, which drives the infrequent participation of households in this asset class. We further show that the households use financial assets as a transitory asset class on their way to accumulating real estate. Our results are consistent with a theoretical model of portfolio choice where households face an adjustment cost to re-adjust their lumpy real estate holdings.

Dynamic productivity growth and its determinants in the Indonesian food and beverages industry

ABSTRACTThis research investigates dynamic productivity growth and its determinants in the Indonesian food and beverages industry decomposing dynamic productivity growth into the contributions of dynamic technical inefficiency change, dynamic technical change, and dynamic scale inefficiency change. The empirical application employs unbalanced panel data of 44 subsectors in the Indonesian food and beverages industry over 1990–2014. To estimate dynamic productivity growth, this research uses a Luenberger indicator accounting for the presence of adjustment costs. The results show that dynamic productivity growth exhibits a decreasing trend. Dynamic technical inefficiency change and dynamic scale inefficiency change contribute positively to dynamic productivity growth, while dynamic technical change contributes negatively. Dynamic productivity growth is affected by the change in industrial concentration, the growth rate of capital intensity, the growth rate of exports, the growth rate of foreign direct investment, and location.

Reputation building through costly adjustment

This paper analyzes quality and reputation management in the presence of adjustment costs. A firm produces and sells experience goods over time. The firm can choose the product quality at any time, but changing it requires a costly investment. Customers learn about the product quality through a quality-dependent Poisson process. We characterize reputational dynamics, showing that the arrival of news may generate jumps in both the firm's quality choice and its reputation. We characterize the set of equilibria as a function of the adjustment costs, and show that the firm can benefit from increased adjustment costs as such costs enhance the credibility of its decisions.

Rational inefficiency, adjustment costs and sequential technologies

In this paper we propose a novel approach to estimate the rational inefficiency of decision making units in the presence of adjustment costs. Using sequential definitions of the production technology, we show how cost inefficiency can be decomposed into rational and residual inefficiency as well as inefficiency caused by technical change. Furthermore, we estimate lower bounds for the unobserved adjustment costs based on unexploited cost reductions due to rational inefficiency. These adjustment costs are used to evaluate the feasibility of exploiting cost reductions caused by residual inefficiency. We demonstrate the empirical applicability of our model by estimating and decomposing the cost inefficiency of U.S. coal-fired power plants using panel data which cover the period between 1994 and 2009.

Levered Returns and Capital Structure Imbalances

We revisit the relation between equity returns and financial leverage through the lens of a tradeoff model with adjustment costs of debt. The model provides a “look-alike” Modigliani-Miller equation according to which equity returns increase with relative leverage, which is defined as the difference between observed leverage and target leverage. The model shows that the traditional positive and linear relation between leverage and returns breaks down in the presence of adjustment costs. We provide empirical evidence that relative leverage is a reliable predictor of equity returns, while leverage is not.

Endogenous Fiscal Growth and Public Macroeconomics

In this research paper, we critically examine the view of capital fundamentalism, claiming that national fiscal policies can be considered as the primary determinant of dynamic and equilibrium economic growth, and then carefully assess the effectiveness of optimal fiscal policy for the economics of welfare, reflecting on familiar externalities associated with public expenditures and taxes. In accomplishing such a hybrid task, we managed to derive rather than postulate the simplest possible formulation of neoclassical origins, aimed at constituting a benchmark for endogenous fiscalist rules, underpinning the role of productive public expenditures and the ensuing complementarity properties for the governmental size and the rate of economic growth. By encompassing traditional and modern literature strands on endogenous growth, the structural analysis is initially developed and subsequently presented in two main thematic units. The first part puts forward an intertemporal model of a small open economy that is suitable to capture the dynamic interdependence of output growth and the real interest rate, in the presence of adjustment costs on private investment, the effective utilisation of which might help determine the rate of public capital accumulation too. According to our analysis, a country that initially experiences a low rate of output growth, with a relatively low public to private capital ratio, can generate and attain a higher long-run rate of economic growth, equivalent to the growth rate of installed capital. A non-trivial role is also attributed to capital efficiency characterising both the analysis of transitional dynamics and the steady-state effects. Intuitively, dependence of government expenditure on the costs of adjustment drives the notional wedge not only between private and public sectors, but also between output growth and intertemporal welfare as it significantly influences the distributive channel of resources allocation. The second part puts emphasis on welfare economics and particularly on the policy dimensions characterising the size of governments and the rate of growth. By introducing a closed-type economy with policy variations, both the roles of productive spending and government financing are greatly enhanced while the analogous effects on production and/or utility are discussed. In this vein, the privately determined choices for saving and growth - after accounting for a partial impact on consumption - may easily end up suboptimal, owing to governmental externalities. As a principal result, it is revealed that the after-tax marginal product of capital, hence the rate of return, depends positively on the ratio of private to public capital, something that sharply contradicts the results obtained in earlier strands of research where the rate of return was invariant with that particular ratio. A rather subsidiary outcome, from reconsidering certain properties of optimal fiscal policy in accordance to conventional priors, is that maximisation of private welfare corresponds to maximisation of the growth rate of the economy, thereby satisfying the natural condition for productive efficiency.

CORPORATE FINANCING BEHAVIOUR OF SHARIAH COMPLIANT E50 SMEs. A PANEL DATA APPROACH OF GMM.

Motivated by the recent outstanding growth of Islamic Finance in Malaysia, this study aims to investigate the debt financing behaviour of Shariah compliant E50 SMEs in Malaysia covering the existence of target debt, speed of adjustment and factors affecting the adjustment speed to target debt from 2009 to 2013. The Shariah Advisory Council (SAC), has set up certain standard of parameters as guidelines and carried out periodical monitoring in classifying Shariah compliant securities like the prohibition of activities that involve interest (riba), gambling (maisir), uncertainties and speculative trading (gharar). The dynamic model employed and estimated using the Generalized Method of Moment (GMM). Under the dynamic model, the observed debt of a firm should be equal to its optimal debt. However, with the presence of adjustment cost, a firm performs only a partial adjustment to be at the target debt. The model revealed certain determinants significantly influence target debt financing. The positive relationship between tangibility and capital structure yielded in this study enhances Shariah imposition that debt must be asset-backed which means a firm operating under Islamic principles cannot have debt exceeding the tangible assets. This study contributes to the literature and fills the gap by exploring into a relatively new area of debt financing which is the dynamic aspects and also help to enhance the understanding on debt financing behaviour of Shariah compliant SMEs in Malaysia.

Does Speculative Activity Have Real Effects?

We examine how opening financial markets for trade in real and "extraneous" risks can affect productive decisions. Agents have heterogeneous beliefs over these risks and trade in financial markets. We find that speculation, especially in "extraneous" risks uncorrelated with productivity can significantly affect productive decisions. Speculation can either decrease or increase real investment and asset prices, even in the presence of adjustment costs or irreversibility in capital investments. Since housing construction is a largely irreversible investment, our model can help to explain a boom and bust in housing construction and asset prices resulting from speculative activity in the financial markets.

The Moderating Effect of Prior Sales Changes on Asymmetric Cost Behavior

ABSTRACT Recent research documents the empirical phenomenon of “sticky costs” and attributes it to a theory of deliberate managerial decisions in the presence of adjustment costs. We refine this theoretical explanation and show that it gives rise to a more complex pattern of asymmetric cost behavior that combines two opposing processes: cost stickiness conditional on a prior sales increase, and cost anti-stickiness conditional on a prior sales decrease. These predictions reflect the structure of optimal decisions with adjustment costs and the impact of prior sales changes on managers' expectations about future sales changes. Empirical estimates for Compustat data support our hypotheses. We further verify our predictions using additional proxies for managers' expectations, and show that our model offers important new insights. JEL Classifications: D24; M41.

Long-Term Optimal Investment Strategies in the Presence of Adjustment Costs

We consider the problem of determining in a dynamical way the optimal capacity level of an investment project that operates within a random economic environment. In particular, we consider an investment project that yields payoff at a rate that depends on its installed capacity level and on a random economic indicator such as the price of the project's output commodity. We model this economic indicator by means of a general one-dimensional ergodic diffusion. At any time, the project's capacity level can be increased or decreased at given proportional costs. The aim is to maximize an ergodic performance criterion that reflects the long-term average payoff resulting from the project's management. We solve this genuinely two-dimensional stochastic control problem by constructing an explicit solution to an appropriate Hamilton--Jacobi--Bellman equation and by fully characterizing an optimal investment strategy.

Effective labor regulation and microeconomic flexibility

Microeconomic flexibility is at the core of economic growth in modern market economies because it facilitates the process of creative-destruction. The main reason why this process is not infinitely fast, is the presence of adjustment costs, some of them technological, others institutional. Chief among the latter is labor market regulation. While few economists object to the hypothesis that labor market regulation hinders the process of creative-destruction, its empirical support is limited. In this paper we revisit this hypothesis, using a new sectoral panel for 60 countries and a methodology suitable for such a panel. We find that job security regulation clearly hampers the creative-destruction process, especially in countries where regulations are likely to be enforced. Moving from the 20th to the 80th percentile in job security, in countries with strong rule of law, cuts the annual speed of adjustment to shocks by a third while shaving off about 1% from annual productivity growth. The same movement has negligible effects in countries with weak rule of law.

Employment protection legislation, adjustment costs and cross-country differences in cost behavior

Central to the economic theory of sticky costs is the proposition that managers consider adjustment costs when changing resource levels. We test this proposition using employment protection legislation (EPL) provisions in different countries as a proxy for labor adjustment costs. Using a large sample of firms in 19 OECD countries during 1990–2008, we find that the degree of cost stickiness at the firm level varies with the strictness of the country-level EPL provisions. This finding supports the theory that cost stickiness reflects the deliberate resource commitment decisions of managers in the presence of adjustment costs.

La rigidità dei prezzi in Italia (Price Stickiness in Italy)

The presence of price stickiness implies that in the short term adjustment to demand or supply shocks takes place through quantities. This paper approaches the issue of nominal price stickiness in Italy by analysing the cross-sectional distributions of the changes in sectoral consumer price indices and the relationships between the moments of such distributions. A preliminary descriptive analysis showed that consumer price cuts are indeed quite rare. The theoretical literature on price rigidity, in particular downwards, suggests some propositions concerning such relationships, which can be empirically tested. In particular, downward price rigidity should imply a positive asymmetric distribution which should become more pronounced as average inflation declines. Consumer price changes in Italy in fact exhibit quite a pronounced positive asymmetry. Moreover, the relative number of months in which the distribution of consumer price changes is right-skewed rises substantially moving from a high to a low inflation environment. On the basis of a Granger-causality analysis we show that, while the asymmetry in the distribution of Italian consumer price changes over the period characterised by high inflation rates was endogenously generated by the presence of adjustment costs, when moderate inflation prevailed the asymmetric behaviour of prices seems to have been due mainly to some form of inherent downward stickiness in the service sector. JEL Codes: E31 Keywords: Prices, Supply

The Moderating Effect of Prior Sales Changes on Asymmetric Cost Behavior

Recent research documents the empirical phenomenon of “sticky costs” and attributes it to a theory of deliberate managerial decisions in the presence of adjustment costs. We refine this theoretical explanation and show that it gives rise to a more complex pattern of asymmetric cost behavior that combines two opposing processes: cost stickiness conditional on a prior sales increase and cost anti-stickiness conditional on a prior sales decrease. These predictions reflect the structure of optimal decisions with adjustment costs and the impact of prior sales changes on managers’ expectations about future sales changes. Empirical estimates for Compustat data support our hypotheses. We further verify our predictions using additional proxies for managers’ expectations, and show that our model offers important new insights.

Leverage and pricing of debt in LBOs

We show that the structure and pricing of debt in LBOs mostly depend on a single characteristic of the target firm, pre-LBO profitability. We find a positive relationship between pre-LBO profitability and deal leverage that is consistent with a dynamic trade-off theory of capital structure in the presence of adjustment costs. We argue that the wide range of debt tranches used in LBO financing can be folded into two main categories, senior and junior debt, where the pricing of senior and junior debt depends on their relative use and on bankruptcy risk. Our evidence also suggests that senior lenders oversupply cheap credit during hot buyout markets.

Impact of Labor Laws on Cost Behavior

Central to the economic theory of sticky costs is the proposition that managers consider adjustment costs when changing resource levels. We test this proposition using employment protection legislation (EPL) provisions in different countries as a proxy for labor adjustment costs. Using a large sample of firms in 19 OECD countries during 1990-2008, we find that the degree of cost stickiness at the firm level varies with the strictness of the country-level EPL provisions. This finding supports the theory that cost stickiness reflects the deliberate resource commitment decisions of managers in the presence of adjustment costs.

A Small Macro-Econometric Model for Greece: Implications About the Sustainability of the Greek External Debt

This paper develops a small-scale macro-econometric model for Greece. The model will be used in order to examine the impact of macroeconomic policies on the real sector of the economy during the very difficult adjustment period that the Greek economy is currently facing. The model combines short-run Keynesian dynamics with a consistent neoclassical supply side. In this version potential output is given by a constant returns-to-scale Cobb-Douglas type production function. In most cases the short-run dynamics are modeled through an Error Correction Mechanism (ECM) which assumes the presence of adjustment costs in order to smooth-out the long-run equilibrium. A public sector side is also used in order to examine the impact of various shocks on public finance (specifically public debt).

The Dynamics of Cash

Little is known about how firms manage their cash policy over time. This paper fills this gap by examining if and how firms manage cash toward a target cash ratio. Estimating partial adjustment models of cash, we find that firms actively adjust their cash toward a target; however, adjustment is imperfect and there is large dispersion in the speed of adjustment across firms. We investigate the causes for this and find evidence consistent with the presence of adjustment costs. We also examine the implications of these results for previous interpretations of cross-sectional results through simulations of firms’ cash paths allowing for costly adjustment. The emerging patterns question the interpretation of some of the standard results in the empirical cash literature.

Sticky Cost Behavior: Theory and Evidence

We synthesize the rapidly-growing literature on sticky costs that provides an alternative model of cost behavior. This model postulates that many costs arise as a result of deliberate resource commitment decisions by forward-looking managers in the presence of adjustment costs, in contrast to the traditional textbook view that costs adjust mechanically with contemporaneous changes in activity. First, we present the theoretical framework of sticky costs, to develop the main empirical hypotheses. Next, we review the empirical evidence and find that it lends strong support to the sticky costs model. We also discuss recent papers that question the validity of the sticky costs approach, and show that their claims are not actually justified because of their unrealistic assumptions and flaws in their econometric analysis. When these problems are fixed, the analysis in these papers actually lends additional support to the sticky costs framework. Finally, we present new comprehensive empirical evidence that also supports the sticky cost framework for the Global Compustat data which includes both developed economies and emerging economies.

Corporate Governance and Liquidity Constraints: A Dynamic Analysis

Rich panel data for a large and representative sample of Estonian firms are used to estimate the sensitivity of access to capital to differing ownership structures. This is done through explicitly modelling firm investment behaviour in a dynamic setting in the presence of adjustment costs, liquidity constraints and imperfect competition. We estimate Euler equations derived in the presence of symmetric and quadratic adjustment costs and both debt and equity constraints. Generalized Method of Moments (GMM) estimates confirm the importance of access to capital in determining investment rates and suggest that firms owned by insiders, especially non-managerial employees, are more prone to be liquidity constrained than others.