How Real Estate Shocks Affect Corporate Investment
When the value of a firm's real estate appreciates by $1, its investment increases by approximately 6 cents.
The ability to pledge collateral enhances a firm's debt capacity, and providing outside investors with the option to liquidate pledged assets acts as a strong disciplining device on borrowers. Therefore, asset liquidation values play a key role in determining a firm's debt capacity. When these asset values decline during business downturns, it can depress investment and potentially amplify the downturn. Indeed, this "collateral channel" often is invoked when discussing the severity of the Great Depression or the extraordinary expansion of the Japanese economy at the end of the 1980s.
In The Collateral Channel: How Real Estate Shocks Affect Corporate Investment (NBER Working Paper No. 16060), authors Thomas Chaney, David Sraer, and David Thesmar attempt to explain the microeconomic foundation for this collateral channel mechanism. Using data from 1993-2007, they find that when the value of a firm's real estate appreciates by $1, its investment increases by approximately 6 cents. This investment is financed through additional debt issues.
The researchers point out that real estate represents a significant fraction of the assets held on the balance sheet of corporations. In 1993, 58 percent of public firms in the United States reported at least some real estate ownership. Among these firms, real estate accounted for 19 percent of their total market value, which suggests that real estate shocks could have substantial effects on aggregate investment.
Chaney and co-authors find that the impact of real estate shocks on investment is even stronger when estimated on a group of firms the authors view as more likely to be credit constrained. To determine whether balance sheet effects explain their findings, the authors compare the sensitivity of firm investment to real estate values for a set of firms that actually acquired real estate during the sample period. They find that the investment spending of these firms is more sensitive to real estate valuations after acquiring real estate than before the purchase of real estate assets.
-- Lester Picker