Product Market Threats, Payouts, and Financial Flexibility

Abstract

We examine how product market threats influence firm payout policy and cash holdings. Using firms' product text descriptions, we develop new measures of competitive threats. Our primary measure, product market fluidity, captures changes in rival firms' products relative to the firm's products. We show that fluidity decreases firm propensity to make payouts via dividends or repurchases and increases the cash held by firms, especially for firms with less access to financial markets. These results are consistent with the hypothesis that firms' financial policies are significantly shaped by product market threats and dynamics.

The Dynamics of Performance Volatility and Firm Valuation

“…Following the empirical literature of real options (e.g., Panousi and Papanikolaou (2012), Badertscher, Shroff, and White (2013)), we identify 6 proxies for irreversibility: firm industry stock beta; ratio of firm idiosyncratic stock return variance to total variance; industry ratio of new capital goods to total capital goods; industry average depreciation rate; industry average ratio of sales of property, plant, and equipment (PPE) to total capital; and industry liquidity ratio. We use two proxies for competition, the Herfindahl-Hirschman Index (HHI) and product market fluidity from Hoberg, Phillips, and Prabhala (2014). The CFV-Q association does not exhibit consistent differences across the subsamples formed on the 6 irreversibility measures or the two competition measures, indicating that our findings are not driven by the real-options effect.…”

“…FLUIDITY The product market fluidity measure by Hoberg, Phillips, and Prabhala (2014). Based on textual analysis of a firm's 10-K filings, fluidity is the dot product between the words used in a firm's business description and the change in the words used by its rivals.…”

“…We use 2 measures of product market competition: the HHI and product market fluidity constructed by Hoberg et al (2014). 9 Lower HHI indicates more intense competition.…”

Market Power in the Portfolio: Product Market Competition and Mutual Fund Performance

“…First, having differentiated products results in more stable cash flows as the barriers to entry are higher (e.g., Peress (2010), Hoberg, Phillips, and Prabhala (2014)). …”

Cash Holdings and Financing Decisions Under Ambiguity

“…the equity premium puzzle and the interest rate puzzle, see Epstein and Schneider, 2010), there are still ill-understood phenomena in corporate finance. Recent studies document a secular increase in the cash holdings of some firms (Bates, Kahle and Stulz, 2009;Denis and Sibikov, 2010;Faulkender and Wang, 2006;Haushalter, Klasa and Maxwell, 2007;Holberg, Phillips and Prabhala, 2014). And yet, one would expect that the precautionary demand for cash should decrease when firms can hedge more effectively as more types of derivatives are available, e.g.…”