The Effect of a Trade The Effect of a Trade Restriction on the Downstream Restriction on the Downstream

Industry: Evidence from the Industry: Evidence from the US-Canada Softwood Lumber US-Canada Softwood Lumber

AgreementAgreement

Nisha Malhotra & Sumeet GulatiNisha Malhotra & Sumeet Gulati

ObjectiveObjective Trade Restriction:Trade Restriction:

• Protection for the import competing industryProtection for the import competing industry Increase in the Product price or arrest declining Increase in the Product price or arrest declining

product pricesproduct prices• SLA: SLA: Export restrictions on Canadian Export restrictions on Canadian

lumber exports to the USlumber exports to the US

Downstream Industry: Downstream Industry: Lumber using Lumber using industries in the USindustries in the US

Methodolgy: Event StudyMethodolgy: Event Study

The Softwood Lumber The Softwood Lumber AgreementAgreement

US ClaimUS Claim• Artificially low Provincial Stumpage fees - Artificially low Provincial Stumpage fees -

Countervailable subsidies. Countervailable subsidies.

April 1996-Softwood Lumber Agreement finalized. April 1996-Softwood Lumber Agreement finalized. • First 14.7 Billion Board Feet (BBF) of softwood lumber First 14.7 Billion Board Feet (BBF) of softwood lumber

exports from Alberta, British Columbia, Ontario, and exports from Alberta, British Columbia, Ontario, and Quebec would enter the US market duty free. Quebec would enter the US market duty free.

• The first 650 million board feet over 14.7 BBF -tax of $50 The first 650 million board feet over 14.7 BBF -tax of $50 per thousand board feet. per thousand board feet.

• Any further exports were subject to a tax of $100 per Any further exports were subject to a tax of $100 per thousand board feet. thousand board feet.

Other provinces- Unrestricted access to the US market.Other provinces- Unrestricted access to the US market.

LiteratureLiterature

Ries (1993) examines the effect of voluntary export Ries (1993) examines the effect of voluntary export restraint agreements (1981) on profits in the Japanese restraint agreements (1981) on profits in the Japanese automobile industry.automobile industry.

Lenway et al. (1996) examine the direct returns to the Lenway et al. (1996) examine the direct returns to the steel industry from the voluntary export restrictions of steel industry from the voluntary export restrictions of 1982 and 1984.1982 and 1984.

Begley et al. (1998) Impact of export taxes during US-Begley et al. (1998) Impact of export taxes during US-Canada’s Memorandum of understandingCanada’s Memorandum of understanding

Timeline for the disputeTimeline for the dispute Softwood Lumber I: 1982Softwood Lumber I: 1982

• US authorities decided no subsidyUS authorities decided no subsidy

Softwood Lumber II: 1986Softwood Lumber II: 1986• 15% provisional duty15% provisional duty• Replaced by 15% export tax in MOUReplaced by 15% export tax in MOU

Softwood Lumber III: 1991Softwood Lumber III: 1991• Canada unilaterally terminates MOUCanada unilaterally terminates MOU• Countervailing case filed: Interim bonding requirementCountervailing case filed: Interim bonding requirement• Canada wins appeal against countervailing duty in CUSTA (1993 Canada wins appeal against countervailing duty in CUSTA (1993

and 1994)and 1994)• US revokes duties against Canadian lumber (Aug 1994)US revokes duties against Canadian lumber (Aug 1994)• Bilateral consultation process for softwood establishedBilateral consultation process for softwood established

TimelineTimeline Clinton visits Ottawa in post-NAFTA Euphoria (Feb Clinton visits Ottawa in post-NAFTA Euphoria (Feb

1995)1995)• Highlights worlds biggest trading relationshipsHighlights worlds biggest trading relationships• Bilateral trade irritants considered minorBilateral trade irritants considered minor• Bilateral Trade at record highBilateral Trade at record high

February 2, 1996: The Coalition for Fair Lumber February 2, 1996: The Coalition for Fair Lumber Imports (CFLI) announces intentions to petition if Imports (CFLI) announces intentions to petition if no pact by Feb 15no pact by Feb 15thth

February 15February 15thth 1996: The basic Softwood Lumber 1996: The basic Softwood Lumber agreement announcedagreement announced

April 3April 3rdrd 1996: Details on Softwood Lumber 1996: Details on Softwood Lumber Agreement FinalizedAgreement Finalized

Event Study Event Study

An event study is used to examine the reaction of An event study is used to examine the reaction of investors to positive or negative news (also called investors to positive or negative news (also called events). events). • Firm’s stock prices at the time of the eventFirm’s stock prices at the time of the event

A simple event study involves the following steps: A simple event study involves the following steps: • Event of interest (event dates) Event of interest (event dates) • Selection of firmsSelection of firms• Predicting "normal" return during the event window in the absence of Predicting "normal" return during the event window in the absence of

the event the event • Abnormal Return=Actual Return-Predicted ReturnAbnormal Return=Actual Return-Predicted Return• Estimating the Average Cumulative Abnormal Return within the event Estimating the Average Cumulative Abnormal Return within the event

window for all the firms.window for all the firms.• Testing whether the Average Cumulative Abnormal return is Testing whether the Average Cumulative Abnormal return is

statistically different from zero.statistically different from zero.

Event Study Event Study

t=0

Estimation Period (365 days)

Event Window (-5, 5)

t= -396

t= -31

Event StudyEvent StudyStandard Market Model to predict Standard Market Model to predict

Abnormal ReturnsAbnormal Returns

itR

itR firm i’s return at date t

-The return of the value weighted NYSE and AMEX index at date t.

mtR

a, B and A - are the parameters to be estimated

EW - is a dummy variable that takes the value 1 for the nth day of the event window and 0 otherwise.

Event Study- Event Study- Events of InterestEvents of Interest

Feb 2Feb 2ndnd 1996: Warning by the US Group 1996: Warning by the US Group““The coalition for fair lumber imports warned that they would The coalition for fair lumber imports warned that they would

petition the US Govt. to impose duties if no pact is reached petition the US Govt. to impose duties if no pact is reached by Feb 15by Feb 15th”th” – – Journal of Commerce inc.Journal of Commerce inc.

Feb 15Feb 15thth 1996: Agreement in Principle 1996: Agreement in Principle““US Lumber Industry welcomes agreement in principle over US Lumber Industry welcomes agreement in principle over

subsidized Canadian Softwood Lumber Imports” – subsidized Canadian Softwood Lumber Imports” – PR PR Newswire AssociationNewswire Association

April 3April 3rdrd 1996: Finalizing of the agreement 1996: Finalizing of the agreement““Canada agrees to tax softwood exports to US….” Canada agrees to tax softwood exports to US….” -Wall Street Journal-Wall Street Journal

Source: LexisNexis AcademicSource: LexisNexis Academic

Event Study - Selection of FirmsEvent Study - Selection of FirmsDownstream Industry/ Users of Softwood LumberDownstream Industry/ Users of Softwood Lumber

Firms belonging to the groups that are members of American Firms belonging to the groups that are members of American Consumers for Affordable homes (ACAH) Consumers for Affordable homes (ACAH)

Short listed firms that fell under lumber using 4-digit Standard Short listed firms that fell under lumber using 4-digit Standard Industrial ClassificationIndustrial Classification• SIC 1521: (Single-Family Housing Construction), SIC 1531 (Operative

Builders), 2451(MobileHomes), and 2452 (Prefabricated Wood Buildings).

• Besides the direct users, we also include suppliers (the wholesale lumber dealers) SIC 5211 (Lumber and other Building Materials).

Checked the website to reconfirmChecked the website to reconfirm

Publicly Listed in NYSE and AMEXPublicly Listed in NYSE and AMEX• Stock Price data - Centre for Research on Security Prices (CRSP) Stock Price data - Centre for Research on Security Prices (CRSP)

database (AMEX, NYSE)database (AMEX, NYSE)

Stock Price Response to SLA Stock Price Response to SLA Event Window (-1,+1)Event Window (-1,+1)

EVENT

News No. of firms

ACA Z STAT Positive: Negative

Z Stat

event 1 Warning by US Producers

37 -1.50% -2.61* 13:24 -1.42 event 2 Agreement Reached in Principle

37 -1.45% -2.63* 11:26 -2.08* event 3 Canada Finalizes the Agreement

37 -2.47% -3.18** 9:28 -2.74**

* significant at 5 % confidence interval level; ** significant at 1 % confidence interval level

6th column-generalised significant test

Lumber is the primary material used in Lumber is the primary material used in new homes.new homes.• An estimated 40 % of US Consumption of An estimated 40 % of US Consumption of

Softwood Lumber is accounted for by Softwood Lumber is accounted for by Construction of new residential homes and Construction of new residential homes and another 30% by remodeling and repair. another 30% by remodeling and repair.

• The National Association of Home Builders The National Association of Home Builders estimate that direct and indirect use of lumber estimate that direct and indirect use of lumber in an average new home is about 16,000 board in an average new home is about 16,000 board feet.feet.

Use of Softwood LumberUse of Softwood Lumber

Stock Price Response, Cumulated over all eventsa , by 4-Digit SIC,

Event Window (-1, +1)

b Others 4-digit SICs: 2515-Mattresses and Bedsprings; 5031-Lumber, Plywood, and Millwork; 5271-Mobile Home Dealers

SIC 4-digit Industries No. of firms TACA Z STAT

1521 Single-family Housing Construction &

Residential Construction, Nec 9 -6.19% -2.90**

1531 Operative Builders 11 -4.22% -0.88

2451 & 2452 Mobile Homes & Prefabricated Wood

Buildings 11 -1.88% 0.04

5211 Lumber and Other Building Materials 6 -12.99% -2.08*

ALL ALL 37 -5.42% -1.84*

Industry Coverage Industry Coverage 1521 - Top 5 builders have 15% of market 1521 - Top 5 builders have 15% of market

share. (Top 8 ~ 26%)share. (Top 8 ~ 26%) Solely engage in building residential homes, Solely engage in building residential homes,

remodeling, and repairing houses. 1531 – Top 8 have 23% of the market 1531 – Top 8 have 23% of the market

share. share. Construction, land acquisitions, sales and a host of Construction, land acquisitions, sales and a host of

other non-constructive activitiesother non-constructive activities 5211- Top 6 leaders in the market5211- Top 6 leaders in the market 2451 & 2452 - 10 manufactured home 2451 & 2452 - 10 manufactured home

producers accounted for 78 percent of producers accounted for 78 percent of total industry shipments.total industry shipments.

Robustness CheckRobustness Check

Stock Price Response for all the eventsStock Price Response for all the eventsVarious Event WindowsVarious Event Windows

Event Window No. of firms TACA Z STAT

(-1,+1) 37 -5.42% -1.84*

(-2,+2) 37 -5.11% -2.03*

(-3,+3) 37 -3.55% -2.27*

(-5,+5) 37 -5.10% -2.19*

* significant at 5 % confidence interval level; ** significant at 1 % confidence interval level

Conclusion Conclusion

We find that events leading to the Softwood Lumber Agreement brought about large and

statistically significant reductions in the stock values of the firms in our sample .

Final Consumers: Final Consumers: • The U.S. Census Bureau :The U.S. Census Bureau : For every 1,000$ increase in housing price For every 1,000$ increase in housing price

300,000 potential homeowners are priced out 300,000 potential homeowners are priced out of the housing market. (lower income families)of the housing market. (lower income families)