New projects: the best approach

New projects: the best approach
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First Published: Fri, Mar 19 2010. 09 25 PM IST

Updated: Fri, Mar 19 2010. 09 25 PM IST
How do business groups choose to implement new projects? Do they start a new firm for every project, or do they implement projects within existing firms? Ayyagari, Gopalan and Yerramilli attempt to find answers to these questions by studying 3,331 new projects started by business groups in India between 1995 and 2007, using the database of the Centre for Monitoring Indian Economy (CMIE). They find that within their sample of 3,331 projects, 82% were integrated within existing firms, while 18% were set up in new firms. Very interestingly, 71% of projects that involved the group diversifying into new industries too were set up within existing firms.
One reason for integrating a new project within an existing firm can be because of operational and financial synergies. Another reason could be to subsidize new projects using the cash flows of existing firms. And a third hypothesis is that promoters prefer to house lucrative projects in firms in which they have a large shareholding.
What do the results show? The authors say, “Our results suggest that a key motive behind integration is to subsidize and support the new project using the cash flows of an existing group firm. Consistent with this idea, we find that larger and more profitable business groups are more likely to integrate projects, and that the integrated projects are more likely to be from less profitable industries. Within the group, projects are more likely to be housed in larger and more profitable group firms.” In other words, the idea is to subsidize the new venture, using the cash flows from a profitable existing firm. The study also finds that promoters prefer to house good projects in firms in which they have a large proportion of shares. The market usually reacts negatively to announcements of new projects, but the reaction is positive if projects are announced within firms that have high levels of promoter shareholding. That’s because, say the researchers, the market believes that such projects are likely to be profitable.
World oil demand’s shift toward faster-growing and less price-responsive products and regions
By Joyce M. Dargay, Institute for Transport Studies, University of Leeds; and Dermot Gately, New York University
If the predictions made in this study about rising oil demand are true, then we are in for a continuous increase in the price of crude oil. The authors say that the world’s per capita fuel demand has remained at 2 litres per day for the last 40 years and this has led to some complacency about the future growth of oil prices. But that statistic hides a significant change. While the Organization for Economic Cooperation and Development (OECD) countries and the former Soviet Union have reduced their per capita consumption of oil, it has tripled in the rest of the world. Also, the factors most responsible for reducing demand cannot be repeated. These were the switch away from using oil in heating and in electricity generation, a process that is nearly complete, and the drop in oil consumption following the collapse of the Soviet Union. Meanwhile, demand for transport and other oil, which is difficult to curb, has increased dramatically.
The authors point out that demand for oil is shifting to developing regions that are growing more rapidly and whose demand is less responsive to higher prices. The upshot: “In contrast to projections to 2030 of declining per capita demand for the world as a whole—by the US Department of Energy, International Energy Agency and Opec (Organization of the Petroleum Exporting Countries)—we project modest growth. Our projections for total world demand in 2030 are at least 20% higher than projections by those three institutions, using similar assumptions about income growth and oil prices, because we project rest-of-world growth that is consistent with historical patterns, in contrast to the dramatic slowdowns which they project.” The extra 20 millions barrel per day consumption in the developing world that the authors envisage is, incidentally, about twice the current production of Saudi Arabia.
Illustrations by Jayachandran / Mint
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First Published: Fri, Mar 19 2010. 09 25 PM IST
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