Cash Flow and Investment Project Outcomes Evidence from Bidding on Oil and Gas Leases

How does a rm s investment change with its cash ow To study this question we collect detailed project level data on oil and gas lease auctions Bidding data on all tracts and bidders including losing ones allow us to track changes in relative bid prices and lease composition Morover outcome data for every lease i e whether minerals where found or not allow us to track changes in pro tability of bids We nd that higher cash ow is associated with higher total spending even after controlling for time and rm xed e ects Interestingly though neither the number nor size of leases increases Instead rms simply bid and pay more for each lease even when controlling for tract characteristics or other bids This e ect is strongest as rms approach the end of their scal year Moreover leases bought when cash ow is high are not more productive In fact they are often less productive We also nd that the negative productivity e ects are strongest prior to the mid s consistent with the view that governance in the oil industry improved then In short when cash ow is high bidders appear to over pay for less productive leases without expanding the scale of operations These results are most consistent with free cash ow theories of investment but one where managers use cash ow to simplify their job or live a quiet life rather than empire build PRELIMINARY AND INCOMPLETE PLEASE DO NOT QUOTE OR CIRCULATE University of Chicago Graduate School of Business NBER and CEPR MIT and NBER Addresses E th Street R D Chicago IL Memorial Drive E a Cambridge MA E mail marianne bertrand gsb uchicago edu mullain mit edu Nahid Rahman provided excellent research assistance We are grateful to seminar participants at the University of Chicago Graduate School of Business Harvard Business School Harvard University University of Michigan and Stanford University for very helpful comments