url
6
Mar
2015

DISPLACED CAPITAL: Theoretical Framework 2


This story, which will be formalized below, contains several key assumptions. We begin by motivating the first assumption of sectoral specificity of capital. We view each piece of capital as comprising a certain set of physical characteristics. When new capital is built for sale to a specific sector, it will have the best match of features for that sector. Despite the specificity of these characteristics, capital can be reallocated across sectors. The key is that only some of the characteristics of a particular piece of capital will have value in another sector.

We illustrate this idea with an example of a wind tunnel. A low-speed wind tunnel capable of producing winds from 10 to 270 miles per hour was sold to a company outside of the aerospace industry (San Diego Union-Tribune Oct. 23, 1994). This company rents the wind tunnel for $900 an hour to businesses such as bicycle helmet designers and architects who wish to gauge air flows between buildings. Most of the users require only low wind speeds and do not value the fact that the tunnel can produce 270 mile per hour wind speeds. Thus, a key characteristic of this wind tunnel – high air speeds – has no value outside of aerospace.

We also believe that thin markets for used capital are an important impediment to the efficient reallocation of capital. Our discussions with professional liquidators and auctioneers suggested several transaction costs in the reallocation of capital. Finding buyers whose needs match the characteristics of the equipment closely is a costly and time-consuming process. The sale of the equipment must be advertised and the process of inspection, negotiation and capital budgeting can be lengthy. On the other hand, the firm can hold a public auction, which takes place over a couple of days, but which may result in inferior matches between capital characteristics and buyers’ needs.
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Several other models in the literature incorporate some of these features. For example, the specialization of capital by industry is a key assumption used in the literature on debt capacity and liquidation of assets (e.g. Williamson(1988), Shleifer and Vishny (1992)). In Shleifer and Vishny’s model, capital may be sold to a lower value use outside the industry because firms inside the industry may be credit-constrained. In our model, capital may be allocated to low-valued uses even with no financial market imperfections because of costs of search.

This story, which will be formalized below, contains several key assumptions. We begin by motivating the first assumption of sectoral specificity of capital. We view each piece of capital as comprising a certain set of physical characteristics. When new capital is built for sale to a specific sector, it will have the best match of features for that sector. Despite the specificity of these characteristics, capital can be reallocated across sectors. The key is that only some of the characteristics of a particular piece of capital will have value in another sector. We illustrate this idea with an example of a wind tunnel. A low-speed wind tunnel capable of producing winds from 10 to 270 miles per hour was sold

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Kevin J. Brandon

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