Households as Corporate Firms:Constructing Financial Statements from Integrated

Household Surveys

Krislert SamphantharakRobert M. Townsend

Plan of the talk…134-page paper in 30 minutes, “Thank you, Rob!”• Overall idea

– Studying financial situations of households• Approach and methodology

– Households as corporate firms– Financial accounting

• Applications– Simple financial analysis– Application to modeling of household behavior

• Kinship networks, liquidity constraints, and household investment• Discussion on high-frequency household survey with detailed

questionnaire– What we get from the survey?– What are the problems?

Main objective

• To better measure productivity, risk, and the financial situation of households in an analysis of high frequency panel data– High frequency data are important for the study of

liquidity, the smoothing of consumption, the protection of investment from cash flow fluctuations, and the financing of budget deficits

• What we need:– Measures of assets, liabilities, wealth, income,

consumption, investment, and financing transactions (savings, borrowing/lending, gift, etc.)

Unfortunately,…

“… The only way to obtain … [these] measures is by imposing an accounting framework on the data, and painstakingly construct estimates from myriad responses to questions about the specific components that contribute to the total…” Angus Deaton, l997

Initial problem that we faced…• There are often large timing differences between

inputs purchased and outputs sold as for farmers with infrequent harvests, and timing differences between inputs acquired and revenue received as for businesses with trade credit

• This necessitates the distinction between cash flow as a measure of liquidity (monthly cash inflows and outflows) and net income as a measure of performance (revenues minus ‘corresponding’ cost of production, including those incurred in different periods)

• (Other problems that we later faced will be mentioned shortly in this presentation)

What we do...

• Draw analogies between households and corporate firms– Households are also production units– Financing, investing, producing, redistributing

• Apply frameworks used in corporate financial accounting to the households and create financial statements for each household in each period

Households as Corporate Firms: Organization Structure

• Extended household as conglomerate with multiple divisions

• Nexus of households related by kinship as business group

• Migration into a household (possibly by marriage) as issuing and selling shares to new shareholders in order to capitalize, or as a merger/takeover

• Migration out of a household (possibly by divorce) as a spin-off

Standard Corporate Financial Statements

• Balance sheet– Assets, liabilities, equities

• Income Statement– Revenues, (associated) costs, accrual net income– Dividends, retained earnings

• Statement of Cash Flows– Cash flows from operation; investment; financing

Households as Corporate Firms: Finance

• Assets (both financial assets and real assets)• Household (formal and informal) debts as firm liabilities• Wealth as equity

– Initial wealth as contributed capital– Savings as retained earnings

• Consumption as dividends• Gifts as equity (or equity-like security) issues

– Because it adds to household assets but it is not debts– Claims on household assets with low seniority (not protected by

law although possibly protected by social norms)• Household budget constraint as firm cash flow constraint

Corporate financial accounts help us distinguish…

• Assets vs. wealth– “How many tractors do you have?”

• Accrual income vs. cash flows– Productivity vs. liquidity

• Savings as budget surplus (as in cash flow statement) vs. savings as change in wealth accumulation (as in balance sheet)

• Liquidity management (of budget deficit) vs. asset & liability management (of wealth accumulation)

Constructing Household Financial Statements from a Household Survey

• Initial survey: Construct initial balance sheet of the household

• Monthly updates: Each transaction is entered in the balance sheet, income statement, and statement of cash flows

• Trivial example: Receive wage income in cash– JM4D: “What is the total amount of cash payments that you

received since the last interview for doing this job?....”– BS: Increase in cash, increase in cumulative savings– IS: Labor income– CF: Cash inflow from production (+)

Non-trivial issues• Multi-period production, storage, and inventory• Outputs from one production activities as inputs

in others• Consumption of home-produced items• Non-cash transactions (in-kind, credit)• Depreciation of fixed assets• Livestock– Birth, mature, aging, and death

• Gifts and transfers• Loan payment, principal repayment, and interest

Using the accounts

• After painfully constructing the financial statements for all of the households for each months, we use the accounts to study household’s behavior and financial situations– Simple financial analysis: Financial ratios etc.– Applications to economic model of household

behavior

• Applying the framework to all of the households in the Townsend Thai monthly survey

Applications: Financial Analysis

• Household productivity– Household’s ability to use its assets or wealth to

generate earnings– Accrual income (rather cash flow)– What we do:• Return on assets (ROA)

– Profit margin ration * asset turnover ratio

• Return on equity or net wealth (ROE)– Profit margin ration * asset turnover ratio * leverage

• Liquidity & Insurance– Cash flow from production (rather than accrual

net income), consumption, and capital expenditure (investment)

– What we do:• Coefficient of variation• Correlation• Simple regression of monthly (consumption and/or

capital) expenditure on cash flow

• Financing of consumption and capital expenditure– From statement of cash flows, we have various financing

devices• Decrease in deposits at financial institution• Decrease in net ROSCA position• Lending (e.g. loan recall)• Borrowing• Net gift received• Decrease in cash holding

– What we do:• Variance decomposition of consumption and/or capital

expenditure deficit

• Asset & liability management– How the households manage their asset and liability

composition when they accumulate (or decumulate) wealth from savings out of net income (retained earnings) and gifts received (new equity issues)

– Look at changes in each item in household’s balance sheet (rather than statement of cash flows)

– What we do:• Variance decomposition of changes in household’s wealth

Some findings

• Consumption and capital expenditure comove with household income

• Cash in hand as the main financing device for household– Borrowing and gifts matter as well

• Nonseparability between consumption and investment– Consumption partly financed by sales of fixed assets– Investment partly financed by reduction in consumption

Applications: Economic models of household behavior

• Applying theories and ideas in financial economics to development economics– Financing of household’s investment in fixed assets:

Pecking-order hypothesis, investment-cash flow sensitivity

– Occupation diversification, income volatility and smoothing, and consumption volatility and smoothing: Portfolio theory

– Risks and returns on household assets: Beta and CAPM

• Other applications presented in this conference

Liquidity constraints and financing of household investment

• Idea: Pecking-order hypothesis in corporate finance– Investment is generally financed by (cheaper) internal

funds first, then by (costly) external finance• Conventional empirical approach: Investment-

cash flow sensitivity– Once controlled for profitability, a firm with more

liquidity constraints should have investment more sensitive to its own cash flow from operation (which is firm’s internal fund)

– Subject to some critiques

• Applying to our households from Townsend Thai monthly survey

• Findings for poor households:– They seem to face liquidity constraints, i.e. their

investment is sensitive to their cash flow from production– The constraints are partially mitigated by kinship networks

in the village– The finding is consistent with the related fact that poor

households with relatives living in the same village have higher fraction of borrowing and gifts from within the village as compared to those without relatives in the village (direct effect of network)

• Findings for the rich households:– Investment-cash flow sensitivity suggests that the rich

households do not seem to have liquidity constraints– But variance decomposition shows that rich households

finance investment from previously accumulated cash, i.e. they use internally generated funds, symptomatic of constraints in a pecking order literature• Our accounting framework allows this distinction– the use of a

stock of cash as opposed to a cash flow• Although investment-cash flow sensitivity implies liquidity

constraints, the reverse is not guaranteed– Rich people in networks actually borrow less from within

the village than do rich non-network households• Possible indirect effect of network on financing???

Discussion on household survey

• We have seen some applications of the high frequency household survey, but what should we concern when we conduct this kind of survey?

• Two issues regarding survey design (in addition to other important issues such as sampling)...– Level of details– Frequency of survey

Detailed questionnaires

• Benefits– Mitigate recall errors– Allow researchers to analyze disaggregated financing devices

that are not perfect substitute– Facilitate the survey in developing countries where accounting

knowledge of the field interviewers and the households might be limited

• Problems– Measurement errors from aggregating the responses from

myriad questions (but hopefully we can think about the direction of the bias better when the variables are better defined)

– Higher monetary cost to the researchers and higher opportunity cost to the households

– Smaller sample size

High-frequency surveys• Benefits

– Allow researcher to study household behaviors that are concealed in annual (or even quarterly) surveys• Short-term liquidity management, inventory management• Seasonal migration and remittances

– Mitigate recall errors• Problems

– Some households may get interviewed around the beginning of the month while others are interviewed towards the end• Risk-sharing regressions and other regressions with common time

dummies must be done carefully to reduce this spurious problem– Even high frequency surveys with once a month interviews miss

the exact timing of planting, and of other inputs and operations within each month, daily rainfall, temperature and other environmental features

Conclusion: High frequency survey with detailed questionnaire

• Our take:– Despite problems with high frequency data and

detailed questionnaires, this kind of survey can be very valuable in the study of certain decisions of households in developing countries

[Extra slides, if time permits]

Issues

• Construction of separate financial statement for each production activity is also possible. However, it is difficult to pin down the allocation of assets to each activity.

• We thus determined overall income, rates of return to all assets, and aggregate ratios, and set aside for now the issue of rates of return and financing of a particular activity.

• Also, we do not distinguish among transactions of family members within the household itself.

Although households and firms are not always analogous…

• Definition of households in surveys– Household as a collection of individuals living in the

same housing structure for at least a certain number of days or sharing certain common expenses together

– Not coincide with a collection of individual registered with the government (Legal definition)

• Definition of firms in financial accounting– Firm as registered business entity (Legal definition)– Corporate firm is considered as judicial person

• Ownership is well defined for a registered firm but is not for a household