|Researchers:||Yangming Bao, Martin Götz|
Topic & Objectives
Peer effects, the impact of a group's behavior on individual behavior, are found to increase productivity in the workplace, foster the accumulation of human capital, contribute to economic development or household financing decisions. Peer effects are also present between firms and empirical work shows that a firm's behavior is also heavily affected by the behavior of peer firms. In this paper, we focus on firm investments and examine how a corporation's investment decision is affected by the investment of its neighbors. To identify the causal impact of firms' investment on their neighboring firms, we use an instrumental variable estimation technique based on the staggered, state-specific increase of corporate income tax rates in the United States.
To identify the causal impact of local firm's investment, we employ a two-stage-least squares (2SLS) estimation technique using changes in state corporate income tax rates as an excluded instrumental variable. In particular, we build our identification strategy on two parts: first, we exploit variations in the exogenous rise in U.S. states' corporate income tax rates to estimate the exogenous component of firm investment. Second, we exploit heterogeneity in the headquarter locations of firms and utilize the fact that not all firms in the same urban area are subject to the same state-specific tax rise since these firms are headquartered in a different state. This allows us to recover the exogenous component of firm investment and hence pin down the causal link of firm investment on a neighboring firm's investment.
Focusing on firms in the same Economic Area, but located in different states and using the exogenous rise in states' corporate income tax rates as an instrumental variable, we find that firms' investment exerts a negative effect on a neighboring firm's investment behavior. Thus different to our OLS findings a firm responds by decreasing investments when neighboring firms increase their investments. This finding also holds if we focus on firms in smaller areas, i.e. firms in metropolitan statistical areas.
In addition to the 2SLS regressions, we perform a reduced form analysis examining how firm investment changes when neighboring states increase corporate income tax rates. Moreover, we examine if the effect of a neighboring state's tax rise differs depending on a firm's proximity to that state. In line with our 2SLS findings, we find robust evidence that firms increase investment when neighboring states raise their corporate income tax rates. Furthermore, we find evidence for a spatial decay of this effect, as the effect is stronger for firms located in counties that are closer to the neighboring state. The increase in neighboring states' corporate income tax rates reduces neighboring firms' investment, and thus our reduced form finding is consistent with our 2SLS analysis.
Our findings contribute to the understanding of local firms' investment behavior. Our finding that firms’ investment behavior exerts a negative effect on neighboring firms also informs work and discussions regarding the understanding between economic activity and firm investment.
- Ordinary-least-squares regression indicate a positive relationship between firms’ investment behavior
- Addressing the endogeneity of firm investment using exogenous changes to corporate income taxes, we find that firm investments are strategic substitutes
|220||Yangming Bao, Martin Götz||Local Peer Effects and Corporate Investment||2018||Corporate Finance||Investments, Peer Firm Effects, Agglomeration, Corporate Income Tax|