BUSINESS EXPECTATIONS AND PLANT EXPANSION With Special Reference to the Rubber Industry DISSERTATION Presented in Partial Fulfillment of the Requirements for the Degree Dootor of Philosophy in the Graduate School of The Ohio State University o ' t & r b Clarence R. Jung, Jr. The Ohio State University 1953 Approved by: leading up to Hicks' contribution follows* Critical opinion usually credits John Maurice Clark with being the first modern economist to recognize and label the economic conditions of the accelerator# as is pointed out above* His work was not very rigorous mathematically and he made relatively few statistical tests of his models* His work did not refer, for example, to some important problems of cycle theory: What are the initiating factors in the oscillations and what are the conditions tinder which the oscillations are likely to be explosive, damped, or constant? Ragnar Frisch offered an explanation of the initiating factors in the oscillations and some conclusions on how these factors seem likely to be sufficient for maintaining the oscillations*9 Initiating factors he said are "exogenous" to the economic system under consideration (for example war, famine, flood, technological change) and come upon it at erratic intervals* These shocks may be likened to successive blows struck at a pendulum swinging against some friction* The blows keep the pendulum swinging at varying amplitudes and speeds* Erratic shocks instigate oscillations, irregular in B T. N. Carver, Aftalion, and Bickerdike clearly formulated such a principle prior to Clark's article in 1919* See Fisher, loc* cit., pp ltfli-7* 9 Frisch, Ragnar, "Propagation Problems and Impulse Problems in Dynamic Economics," Economic Essays in Honour of Gustav Cassel, London: Geo Allen and Unwin, Ltd.T"l933. pp 171-205. - 95*“ Modigliani suggests that a multivariate analysis of ex post data (on sales* investment* prices* and so on) be carried out.^® Management interviews should provide information on the extent of forward planning* degree of formalization and adherence to such planning, as well as the role of budgets. The basic hypothesis employed in the Merrill Project was that "current expectations together with other current data" exert a significant influence on forward investment plans. The investigators sought to employ a "panel study" con­ cerned with the role of sales forecasts* long-run outlook of top management, lines of authority for acceptance of new projects* criteria for accepting new projects* role of availability of internal funds* and other factors. From four to six "repeated interviews" with individuals within the firms were planned for this purpose• The Korean conflict altered plans somewhat* but the results of one "wave" of interviews were reported in mimeographed form. Several tentative conclusions were reached on the basis 20 Modigliani notes that ex post data may fail to account fully for the relation of planned to realized investment because the behavior of the variables treated may have been anticipated in the original plan. Of. Hart's conditions for fulfillment of expectations summarized in Chapter TVro. ~ 9 6 ~ of initial interviews. First, the sales forecast (for the firms in this particular manufacturing industry) plays a central role in planning operations for a year into the future. This is true because of the seasonality of sales. Sales are con­ centrated near the planting and harvesting seasons, and are spread into a variety of products. For economical production (best use of plant, manpower, and inventories) firms usually try to produce at an even rate. This means that they often produce all of one article within a short portion of the year, often four to six months prior to the time they will be sold. Second, the production schedule was found to be extremely important. Significant penalties attach to over and under­ production and a firm's cash position was found to be a key to the officials' attitude toward over and under-production. ^hird, only a few firms engaged in long-term demand forecasts relative to the need for additional capacity. Post-World War II years did find some firms making formal plans for expansion, but this was mostly terminated by 19k9* Gash positions seemed to be important, and where cash positions were felt to be weak, a close budgeting control was kept on ex­ pansion and a very short pay-off period required. Fourth, little information was available on the origin and - 9 7 - basis of expectations. Sales forecasts were generally derived from the field sales force predictions, sometimes with the aid of national income and industry data, and were usually adjusted downward, Die interviewers did not press this question very far so that it is not clear what information could have been obtained had more questions been turned in that direction® In a recent study of investment decisions in Michigan firms, Katona and Morgan found sales and orders to be significant. Other important factors were technological changes forced rn by competitors, and long-run expansion in growing industries,1^ In another study, Long called attention to the importance of expectations in the building cycle. He states that "among the many things we need to know is just how far into the future expectations normally extend and whether the length pp of this extension ever shows appreciable changes."^ The Merrill Project included a summary of the various types of data which already exist relative to investment plans and expectations. One of these sources is the Department of Commerce-Securities Exchange Commission canvas of firms registered 21 Katona^ George, and Morgan, James N., "Ihe Quantitative Study of Factors Determining Business Decisions," Quarterly Journal of Economics, Vol. 66, No. 1, February, 1952, pp 67-90. 22 Long, Clarence D., Jr., Building Cycles and the Theory of Investment, Princeton University Press, 19U0, p 52. A study of planning in electric power industry by G-ort cited later in this chapter indicates that the horizon is always short. - 9 8 - with the Securities Exchange Commission and a sample of unregistered firms. In this survey* firms are asked concerning l) the expected outlays for new plant and for new equipment during the next quarter 2) the estimated outlays during the current quarter and 3) the actual outlays during the previous quarter. They also are asked to estimate expected investment and expected sales for a whole calendar year ahead.^ Friend and Bronfenbrenner studied some of this material in connection with realization and non-realization of planned investment. Using a follow-up* multiple choice questionnaire they gained additional information con­ cerning why certain firms had realized* or not realized* their investment plans. They found that large firms are much more accurate in their anticipations of actual investment and that large scale investments are more accurately predicted than small ones. Hhey found also that changes in sales and earnings had only a slight effect on realization of investment pro­ grams* but a major effect (one-half the cases studied) on non-realization. However* contrary to what one would pre- 23 ! “ * " ” " • ’ 1 w " C.s - 99- dict from, say Hart’s analysis, liquidity position, working capital requirements, unfilled orders to sales had slight detectable effect on non-realization* Changes in availability of debt and equity financing were "quite unimportant" in non-realization* 2he chief factors tending to increase investment be­ yond plans were changes in the supply of plant and equipment 2k material, competitive conditions, and new products* In addition to the Department of Commerce-Securities Exchange Commission reports, there are several other efforts currently being made to gather information on plans, anticipations, and expected investment* For instance, Dun and Bradstreet survey about one thousand business executives monthly* They are representative of "larger, typicil manufacturers, wholesalers, and retailers located throughout the United States•" 25 They ask merely whether their respondents expect their net sales, net profits, inventories, selling prices, and number of employees in a particular quarter of one year to increase or decrease com­ pared with these figures for the same quarter of the previous year. A McGraw-Hill survey asks "larger" concerns in manu­ ali Friend, Irwin and Bronfenbrenner, Jean, "Business Investment Programs and Qheir Realization," Survey of Current Business, Vol 30, No 12, December, 1952, pp 11-22. 25 "Compass Points of Business," Supplement to Dun’s Review, February, 1951, p 7. - 1 0 0 - facturing, mining, and transportation about investment plans for a few years in the future, expected increase in capacity, and policies followed in modernizing equipment Fortune magazine polls an undisclosed sample of executives, asking them their estimate of future business trends and their own plans for the future* Considerably before the "flurry” of surveys on expectations, Dice and Eiteman found that money payments made by firms were a response to the anticipation of money receiptsLike Angellfs work (cited in the Appendix) their study did not specify the nature of the mental selection of encouraging and discouraging data* However, a study of bank balances of a sample of firms (small manufacturing, wholesale, retail) indicated that only the expectation of a favorable "clearing balance" could induce them to action by way of expenditures* Inferences from this study, and other evidence, indicate the inadequacy of the traditional quantity theory of money* William