Why do Firms Purchase Used Assets?

AuthorSaima Javaid,Khadija Harery,Mufaddal Baxamusa
Published date01 June 2016
Date01 June 2016
Why do Firms Purchase Used Assets?*
University of St Thomas, St Paul, MN, USA and
King Abdulaziz University, Jeddah, Saudi Arabia
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
nd 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
identication. In contrast to the literature, we nd no empirical support for
financial constraint as a reason for purchasing used assets.
JEL Codes: G34; G30; G31
We investigate whether the purchase of used assets is more likely when an indus-
try is undergoing signicant technological change. A used asset is an asset that
one rm divests and another purchases. Between 1980 and 2013, rms traded
$3.1 trillion worth of used assets, reecting the signicance of this market. In this
strand of the literature, the key reason why rms purchase used assets is because of
nancial constraints (Eisfeldt and Rampini 2007). The argument is that the
cheaper price of the used asset motivates the nancially constrained rm to
purchase this asset. No doubt, this argument explains the behavior of some rms;
however, most of the rms in the USA are not nancially 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 inuenced by the expectation that this new technology will be a substan-
tially improved substitute for the current technology. The rm 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 ll the rms immediate needs.
* This project was funded by the Deanship of Scientic Research, King Abdulaziz University (KAU).
The authors gratefully acknowledge technical and nancial support of KAU.
© 2016 International Review of Finance Ltd. 2016
International Review of Finance, 16:2, 2016: pp. 243264
DOI: 10.1111/ir.12084
We build on this insight from the literature on technological expectations by
hypothesizing that increases in the expectations about future signicant 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 rms 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 rms try to extract the maximum
out of their purchase by decreasing the time taken to complete the transaction.
An incentive to the rm to adopt new technology is that it can charge a
premium from its customers. Absent this incentive, the rm 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
rst 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 nd that there is a positive relation between the
purchase of used assets and the expected change in technology.We also nd 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 rm to quickly incorporate a used asset so that it can
enjoy the assets 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 nd no support for nancial constraint
as an explanation for the rms 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.
The nancial constraints of the rm (Eisfeldt and Rampini 2007) is the prevalent
explanation in the literature for why rms 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

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