The dynamic effects of real options and irreversibility on investment and labour demand

This paper shows that, contrary to common beliefs, the real options effect of uncertainty plays no role in the long run rate of investment. This is proven for both the standard investment model with Cobb-Douglas production and Brownian motion demand, and also for a broader class of models with multiple lines of capital, labor and general demand stochastics. Real options and irreversibility, however, are shown to play an important role in the short run dynamics of investment and labor demand. Specifically, they reduce the short run response of investment and hiring to current demand shocks, and lead to a lagged response to past demand shocks.

The Impact of Uncertainty Shocks

Uncertainty appears to jump up after major shocks like the Cuban Missile crisis, the assassination of JFK, the OPEC I oil-price shock and the 9/11 terrorist attack. This paper offers a structural framework to analyze the impact of these uncertainty shocks. I build a model with a time varying second moment, which is numerically solved and estimated using firm level data. The parameterized model is then used to simulate a macro uncertainty shock, which produces a rapid drop and rebound in aggregate output and employment. This occurs because higher uncertainty causes firms to temporarily pause their investment and hiring. Productivity growth also falls because this pause in activity freezes reallocation across units. In the medium term the increased volatility from the shock induces an overshoot in output, employment and productivity. Thus, second moment shocks generate short sharp recessions and recoveries. This simulated impact of an uncertainty shock is compared to VAR estimations on actual data, showing a good match in both magnitude and timing. The paper also jointly estimates labor and capital convex and non-convex adjustment costs. Ignoring capital adjustment costs is shown to lead to substantial bias while ignoring labor adjustment costs does not.

A Generalised Model of Investment under Uncertainty: Aggregation and Estimation

We propose a structural model of investment which is based on the aggregation of (S,s) investment projects within firms. This encompasses the findings that whilst firm level investment is smooth, plant level investment is lumpy and frequently zero. We undertake stochastic aggregation and derive a structural firm level investment estimator. The empirical performance and fit of this estimator on a panel of manufacturing firms is encouraging and provides an avenue for general policy simulation. This model also explains the rich non-linear dynamics of firm level investment data and the frequent simultaneity of firm level investment and disinvestment. This approach provides an alternative structural estimator to the standard convex adjustment cost models, such as Tobin's Q and the Euler equation. The is important because these estimators, which assume quadratic adjustment costs, appear to be misspecified and subject to a fallacy of composition between smooth firm level investment and lumpy plant level investment. For completeness we also consider time aggregation as an alternative source of smoothing but statistically reject this as being insufficient to smooth investment alone. This test also rejects most plant level data, such as the US\ LRD and UK\ ARD, as being generated from a single (S,s) process.

Uncertainty and the Dynamics of R&D

Uncertainty varies strongly over time, rising by 50% to 100% in recessions and by up to 200% after major economic and political shocks. This paper shows that higher uncertainty reduces the responsiveness of R&D to changes in business conditions - a "caution-effect" - making it more persistent over time. Thus, uncertainty will play a critical role in shaping the dynamics of R&D through the business cycle, and its response to technology policy. I also show that if firms are increasing their level of R&D then the effect of uncertainty will be negative, while if firms are reducing R&D then the effect of uncertainty will be positive.

Patents, productivity and market value: evidence from a panel of UK firms

Patents citations are a potentially powerful indicator of technological innovation. In this paper we describe the IFS-Leverhulme patents dataset that we have constructed by combining information from the US Case-Western Patent database with UK company accounts and share price information from the London Stock Exchange. Patents citations like patentc ounts, arehighly skewed and have a modal lag of four years. Analysing data on over 200 major British firms since 1968, we show that patents have an economically and statistically significant impacton firm-level productivity and market value. Patent citations contain more information than simple counts. A doubling in the stock of citation-weighted patents is associated with a four percent increase in (total factor) productivity and an eight percent increase in market value. As expected patenting and citation information feeds into market values immediately but appears to have some additional lagged effects of productivity suggesting gradual takeup of new technologies.Patents, productivity, market value

Does Management Matter? Evidence From India

A long-standing question in social science is to what extent differences in management cause differences in firm performance. To investigate this we ran a management field experiment on large Indian textile firms. We provided free consulting on modern management practices to a randomly chosen set of treatment plants and compared their performance to the control plants. We find that adopting these management practices had three main effects. First, it raised average productivity by 11% through improved quality and efficiency and reduced inventory. Second, it increased decentralization of decision making, as better information flow enabled owners to delegate more decisions to middle managers. Third, it increased the use of computers, necessitated by the data collection and analysis involved in modern management. Since these practices were profitable this raises the question of why firms had not adopted these before. Our results suggest that informational barriers were a primary factor in explaining this lack of adoption. Modern management is a technology that diffuses slowly between firms, with many Indian firms initially unaware of its existence or impact. Since competition was limited by constraints on firm entry and growth, badly managed firms were not rapidly driven from the market.management, organization, IT, productivity and India

Does Product Market Competition Lead Firms to Decentralize?

There is a widespread sense that over the last two decades firms have been decentralizing decisions to employees further down the managerial hierarchy. Economists have developed a range of theories to account for delegation, but there is less empirical evidence, especially across countries. This has limited the ability to understand the phenomenon of decentralization. To address the empirical lacuna we have developed a research program to measure the internal organization of firms - including their decentralization decisions - across a large range of industries and countries. In this paper we investigate whether greater product market competition increases decentralization. For example, tougher competition may make local manager's information more valuable, as delays to decisions become more costly. Since globalization and liberalization have increased the competitiveness of product markets, one explanation for the trend towards decentralization could be increased competition. Of course there are a range of other factors that may also be at play, including human capital, information and communication technology, culture and industrial composition. To tackle these issues we collected detailed information on the internal organization of firms across nations. The few datasets that exist are either from a single industry or (at best) across many firms in a single country . We analyze data on almost 4,000 firms across twelve countries in Europe, North America and Asia. We find that competition does indeed seem to foster greater decentralization.

Trade Induced Technical Change? The Impact of Chinese Imports on Innovation, IT and Productivity

We examine the impact of Chinese import competition on broad measures of technical change - patenting, IT, R&D, TFP and management practices - using new panel data across twelve European countries between 1996-2007. We correct for endogeneity using the removal of product-specific quotas following China's entry into the World Trade Organization. Chinese import competition (1) led to increased technical change within firms; and (2) reallocated employment between firms towards more technologically advanced firms. These within and between effects were about equal in magnitude, and appear to account for 15% of European technology upgrading over 2000-2007 (and even higher when allowing for offshoring to China). Rising Chinese import competition also led to falls in employment, profits, prices and the share of unskilled workers. By contrast, import competition from developed countries had no effect on innovation. We develop a simple "trapped factor" model that is consistent with these empirical findings.China, technical change, trade, firm survival, employment

Recent Advances in the Empirics of Organizational Economics

We present a survey of recent contributions in the empirical organizational economics, focusing on management practices and decentralization. Productivity dispersion between firms and countries has motivated the improved measurement of firm organization across industries and countries. There appears to be substantial variation in management practices and decentralization between countries, but especially within countries. Much of the poorer average management quality in countries like Brazil and India seems due to a "long tail" of poorly managed firms, which barely exist in the US. Many basic economic theories are supported by this new data. Some stylized facts include: (1) competition seems to foster improved management and decentralization; (2) larger firms, skillintensive plants and foreign multinationals appear better managed and are more decentralized; (3) family owned and managed firms appear to have worse management; (4) firms facing an environment of lighter labor market regulations, and more human capital intensive organizations specialize relatively more in "people management". There is evidence for complementarities between ICT, decentralization and management, but the relationship is complex and identification of the productivity effects of organizational practices remain a challenge for future research.productivity, organization, management, decentralization