Research by Thomas Bates, Dean’s Council of 100 Distinguished Scholar and Associate Professor of Finance
o many businesses, automation has a negative side — complicated customer service call systems that drive consumers away, cyberattacks on vulnerable networks, staff lacking in manual-process skills.
But research by two W. P. Carey professors reveals there is a positive side to automation, in that it affords greater financial flexibility to certain types of firms.
Thomas Bates, Dean’s Council of 100 Distinguished Scholar and associate professor of finance, and Jessie Jiaxu Wang, assistant professor of finance, found that a firm’s ability to substitute automation for labor helps determine its corporate financial policy.
Specifically, they found that firms that can’t easily replace employees with machines, artificial intelligence, or data analytics tend to be conservative in their financial policies. Such firms hold more cash, use less debt, and pay lower dividends than their counterparts, all to protect themselves from labor-related expenses such as rising wages for skilled workers or increased costs of hiring and firing.
On the other hand, Bates and Wang found firms that can more easily replace employees with automation tend to have more flexible financial policies. These firms hold less cash, use more debt, and pay higher dividends than their counterparts. When these firms experience shocks to their operating cash flow, such as corporate tax increases, they’re more likely to take advantage of their ability to increase automation and the use of debt.
“We like to take a corporate finance perspective and try to understand how the nature of technology integration, or the ability of a firm to replace human workers with automated capital, can affect its financial policies,” Wang says. “And financial policies are one of the major decisions that managers have to make.”
They created a predictive measure they call Substitutability of Labor with Automated Capital, or SLAC, to reflect the proportion of an industry’s existing employees who are susceptible to replacement by automation. The lower the SLAC, the smaller the share of workers who potentially could be replaced.
The team sorted the firms into industries with the lowest and highest abilities to substitute automation for labor. The differences were subtle and sometimes surprising, Bates says, because they depended less on an occupation’s skill level than on whether computers could figure out how to do a job. Among the industries the team found were less able to automate were childcare, health care, educational services, and research and development. Among those more able to automate were restaurants, transportation, gas stations, stores, and logging.
The researchers found that firms with high abilities to automate held 25–26% less cash, had nearly 10% more leverage, and paid up to 22% higher dividends than firms whose workers were more difficult to replace with automation. This ability frees up capital in a market, Bates says, which then can be used for investments instead of sitting unproductively in company coffers.
“We’re saying the ability to potentially automate relaxes the constraint that labor imposes on companies’ financial policies, so they’re able to hold less cash, which is a good thing for the value of the company,” he explains. “They’re able to take on more debt than they otherwise would, which again will increase the value of the company, and they’re able to pay out more of their operating cash flows to their shareholders in the form of dividends. All of those things, all else equal, should be value-enhancing for shareholders.”
The team’s research pre-dated the COVID-19 pandemic, but Wang and Bates say it became even more relevant as firms used technology to meet the need for working from home and social distancing and as corporate earnings plummeted. It has lessons for both employees and managers as jobs change over time, the two say.
Workers should be ready to acquire new skills, collaborate with technology, or move into jobs that are harder to automate, Bates says. “The lesson for workers is twofold: Don’t panic, you’re not going to be replaced tomorrow just because you work for a railroad or because you drive an Uber,” he says. “That also means that every person in the labor market is aware that the timeline of a career is now much more dynamic than it was 50 years ago.”
For their part, “We want managers to understand that to make rational, sophisticated decisions about their financial policies, they want to look at the potential flexibility coming from their production side,” Wang says. “The nature of their workforce, whether their workforce can be automated, these are very important aspects to consider.”
— Jane Larson