Ebook The Business Cycle, Financial Performance, And The Retirement Of Capital Goods
In order to establish a theory which can be tested empirically with existing macroeconomic data, the neoclassical investment literature assumes that a firm’s capital stock is homogenous, lasts forever and depreciates at a constant rate which is unrelated to economic conditions. These assumptions homogeneity, stability, and exogeneity are critical for estimating the determinants of investment and are by no means innocuous. In practice, investment data concern only capital expenditures gross investment rather than the theoretically appropriate net investment. The difference is depreciation and capital retirement. To the extent that the conventional literature is correct to assume depreciation and capital retirement are exogenous and constant, fluctuations in gross investment are the same as fluctuations in true net investment. If, however, the assumptions about depreciation are not valid and economic factors matter, especially if the factors are the same ones that influence capital expenditures, then the impact that they have on gross investment (estimated in the conventional literature) may be quite different from their impact on true, net investment. This problem will also influence measured productivity.
When capital is heterogeneous it is difficult to believe that depreciation or retirement are constant and exogenous. As discussed in an early literature by Feldstein and Rotschild (1974) and Feldstein and Foot (1971), constant depreciation with differing rates across goods can create “lumpiness” in investment and “echoes” of past investment in future decisions. Boddy and Gort (1971) noted early that there is evidence of capital heterogeneity across sectors and more recent work by Goolsbee and Gross (1997) has demonstrated how important capital heterogeneity for the study of investment at the micro level.
In the area of capital retirements, recent advances in macroeconomics have shown that in vintage capital models with embodied technological progress, the depreciation and obsolescence of capital become economic decisions rather than consequences of physical decay. Firms must decide when it makes sense to replace old machines and this non-representative agent situation has important predictions of what should influence capital retirement and also has some key macroeconomic implications.
Cooper and Haltiwanger (1993) and Caballero and Hammour (1994, 1996) present models with vintages where firms concentrate retirements and “destruction” during recessions when the opportunity cost of reallocation is lowest. This implies that, empirically, the retirements of existing capital should be negatively correlated with the business cycle. Cooley, Greenwood, and Yorukoglu (1995) show that firms should replace existing capital when the price of new capital is low, i.e., retirements should be negatively related to prices and positively related to financial performance if it lowers the cost of funds. Other authors have shown the importance of vintage capital for measurements of productivity growth (Greenwood, Hurcowitz, and Krusell, 1997), learning by doing (Bahk and Gort, 1993 or Klenow, 1998), and firm survival (Agarwal and Gort, 1997).
Direct testing of these theories at the micro level is important for our understanding of investment but a lack of data has made capital retirement the invisible twin of capital expenditure. Nonetheless, given the right data, these new theories are testable against the neoclassical model because the neoclassical model makes a very clear prediction: economic factors should not matter for retirement. In the neoclassical view, depreciation and retirement are physical, exogenous processes and, strictly interpreted, capital should last forever. While this may seem a rather stringent model to test, these assumptions are critical for the neoclassical investment literature. If
the assumptions fail, it means that changes to gross investment and net investment are not the same and the results from the empirical investment literature may not be valid. In contrast, the new theories of investment imply that the business cycle, the cost of capital, financial performance and any shocks to the relative productivity of a particular type of capital should have identifiable effects on retirements.
This paper turns to a unique micro data set on capital decisions in the airline industry from 1972-1984 in order to test these theories. The data concern decisions about one of the most common jet airplanes of all time the Boeing 707 and follow individual capital goods where vintage and retirement are directly observed. The individual capital goods are matched to detailed data on financial performance, the business cycle, factor prices, and the cost of capital. While airlines may not be representative of the rest of the economy, the results from this micro data provide direct, unmistakable evidence that vintage is important for capital retirements and that economic factors do play an important role and of precisely the form predicted by the new investment models. The fact that many of the factors influencing retirement in this industry are the same ones normally used in the investment literature to explain capital expenditures may have important implications for our empirical understanding of true investment behavior and productivity measurement.
The paper is divided into eight sections. Section 2 presents a model of the capital retirement decision. Section 3 gives background on the airline industry, the 707, and the data. Section 4 presents the empirical methods and specifications. Section 5 presents the basic results while section 6 shows them to be robust to alternative explanations. Section 7 gives some macroeconomic implications and the final section concludes.
Download
PDF Ebook The Business Cycle, Financial Performance, And The Retirement Of Capital Goods
Posted in :
