Comparing the Investment Behavior of Public and Private Firms

Abstract

We evaluate differences in investment behavior between stock market listed and privately held firms in the U.S. using a rich new data source on private firms. Listed firms invest less and are less responsive to changes in investment opportunities compared to observably similar, matched private firms, especially in industries in which stock prices are particularly sensitive to current earnings. These differences do not appear to be due to unobserved differences between public and private firms, how we measure investment opportunities, lifecycle differences, or our matching criteria. We suggest that the patterns we document are most consistent with theoretical models emphasizing the role of managerial myopia.Key words: Corporate investment; Q theory; Private companies; Managerial incentives; Agency costs; Short-termism; Managerial myopia; IPOs.JEL classification: D22; D92; G31; G32; G34. This paper compares the investment behavior of stock market listed (or 'public') firms to that of observably similar privately held (or 'private') firms, using a novel panel dataset of private U.S. firms that contains data for around 250,000 firm-years over the period [2001][2002][2003][2004][2005][2006][2007]. Almost everything we know about corporate investment at the micro level is based on evidence from public firms, 1 which number only a few thousand, yet private firms form a substantial part of the U.S. economy. 2 We estimate that in 2007, private U.S. firms accounted for 54.5% of aggregate non-residential fixed investment, 67.1% of privatesector employment, 57.6% of sales, and 20.6% of aggregate pre-tax profits. Nearly all of the 6 million U.S. firms are private (only 0.08% are listed), and many are small, but even among the larger firms, private firms predominate: Among those with 500 or more employees, for example, private firms accounted for 85.6% in 2007. 3 Our empirical tests unearth two intriguing new patterns. First, a nearest-neighbor matching estimator reveals that private firms invest substantially more than do public firms matched on size and industry. On average, private firms invest nearly 10% of total assets a year compared to only 4% among public firms.Second, private firms are 3.5 times more responsive to changes in investment opportunities than are public firms, based on standard investment regressions in the tradition of tests of the Q theory of investment (see Hayashi (1982) or, more recently, Gomes (2001), Cummins, Hassett, and Oliner (2006), Bloom, Bond, and van Reenen (2007), or Bakke and Whited (2010)).The difference in investment sensitivities does not appear to be driven by lifecycle effects, how we measure investment opportunities, or which characteristics we match on. In addition, we exploit a plausibly exogenous tax shock to sidestep the need to directly measure investment opportunities, which may be measured with error. This experiment reveals that private firms respond strongly to changes in investment opportunities whereas public firms barely respond at all. In another alterna...

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