Why do Firms Purchase Used Assets?

• Author: Saima Javaid,Khadija Harery,Mufaddal Baxamusa
• DOI: http://doi.org/10.1111/irfi.12084
• Published date: 01 June 2016
• Date: 01 June 2016

Why do Firms Purchase Used Assets?*

MUFADDAL BAXAMUSA

†

,SAIMA JAVAID

‡

AND KHADIJA HARERY

‡

†

University of St Thomas, St Paul, MN, USA and

‡

King Abdulaziz University, Jeddah, Saudi Arabia

ABSTRACT

We hypothesize that the increase in expectation about future technological

change decreases the likelihood for the purchase of new assets because the

change may make the new assets obsolete. To test this hypothesis, we use pat-

ents and citations data to represent the expected technological change. We

find that the purchases of and the amount spent on used assets increase with

the expectation of technological change, while time to completion of the

purchase and the number of bids decrease with the increase in expectations

about technological change. We exploit industry deregulations to establish

identification. In contrast to the literature, we find no empirical support for

financial constraint as a reason for purchasing used assets.

JEL Codes: G34; G30; G31

I. INTRODUCTION

We investigate whether the purchase of used assets is more likely when an indus-

try is undergoing significant technological change. A used asset is an asset that

one firm divests and another purchases. Between 1980 and 2013, firms traded

$3.1 trillion worth of used assets, reflecting the significance of this market. In this

strand of the literature, the key reason why firms purchase used assets is because of

financial constraints (Eisfeldt and Rampini 2007). The argument is that the

cheaper price of the used asset motivates the financially constrained firm to

purchase this asset. No doubt, this argument explains the behavior of some firms;

however, most of the firms in the USA are not financially constrained and they

account for thevast majority of the purchases of usedassets. The literature puts for-

ward an alternate explanation based on theexpectations about the future changes

in technology. Rosenberg (1976) argues that the decision to adopt a new technol-

ogy is influenced by the expectation that this new technology will be a substan-

tially improved substitute for the current technology. The firm might then not

purchase the current cutting edge technology because this technology might

become obsolete soon (refer also to Farzin et al. 1998). Thus, the result should be

an increase in the purchase of older technology to fill the firm’s immediate needs.

* This project was funded by the Deanship of Scientific Research, King Abdulaziz University (KAU).

The authors gratefully acknowledge technical and financial support of KAU.

© 2016 International Review of Finance Ltd. 2016

International Review of Finance, 16:2, 2016: pp. 243–264

DOI: 10.1111/irfi.12084

We build on this insight from the literature on technological expectations by

hypothesizing that increases in the expectations about future significant techno-

logical changes increase the perceived obsolescence of new assets. This perception

results in the decrease in the cost of purchasing used assets. This decrease results

in firms spending more on used assets than new assets as they wait for the sub-

stantially improved new technology to emerge. We also hypothesize that as the

economic life of the used asset decreases, the firms try to extract the maximum

out of their purchase by decreasing the time taken to complete the transaction.

An incentive to the firm to adopt new technology is that it can charge a

premium from its customers. Absent this incentive, the firm prefer to may

purchase cheaper used assets. We further hypothesize that industries with

regulations that limit competition and have some control over the prices they

charge their customers might also prefer used assets. Examples of these regulated

industries include industries that generate, transmit, and distribute electricity,

industries that transmit and distribute natural gas, etc.

We empirically test these hypotheses with data from SDC for the sample years

1980 to 2013. For the expected technological change, we use two measures. The

first measure uses annual patent applications as an ex-ante proxy for the

expected technological change because these applications can result in new

technology. The drawback of this measure is that many patent applications are

frivolous. So, the second measure uses the citations of the patents. The rational

is that the important patents are likely to be cited more often.

In support of our hypothesis, we find that there is a positive relation between the

purchase of used assets and the expected change in technology.We also find that the

value of the purchased assets decreases with the increase in the expected change in

technology. These results indicate that the expected change in technology decreases

the price of the used asset that in turn results in more used assets being purchased.

Furthermore, we estimate a negative relation between the time to completion and

the expected technological change. This result indicates that the expected techno-

logical obsolescence leads the firm to quickly incorporate a used asset so that it can

enjoy the asset’s economic life longer. Lastly, we use industry deregulations to iden-

tify the technological change. In contrast to Eisfeldt and Rampini (2007) and

Rampini (2015), in our empirical tests we find no support for financial constraint

as an explanation for the firm’s decision to purchase used assets.

The rest of this paper is as follows. We review the literature and develop the

hypothesis in Section II. Section III contains descriptions of the data and the

construction of the variables. Section IV presents the empirical results in support

of our hypothesis. We conclude in Section V.

II. LITERATURE REVIEW AND HYPOTHESIS DEVELOPMENT

The financial constraints of the firm (Eisfeldt and Rampini 2007) is the prevalent

explanation in the literature for why firms purchase used assets. The other

explanations in the literature are productivity changes (Maksimovic and Phillips

International Review of Finance

© 2016 International Review of Finance Ltd. 2016244