CAMBRIDGE, Mass., December 1, 2011—It’s not surprising that proximity can have a substantial impact on business. After all, banks often are more inclined to loan to local borrowers. Venture capitalists are more likely to serve on boards of local firms. And mutual fund managers tend to earn higher returns on investments in local firms. However, what is the effect of proximity within firms? MIT Sloan School of management Prof. Xavier Giroud recently found that companies invest more in plants located closer to headquarters and that those plants tend to be more productive.
“The common understanding is that proximity facilitates monitoring and access to information. But all of this evidence comes from arms’ length transactions and virtually nothing is known about whether proximity affects investments within firms,” he says. “I wanted to find out if it matters how close firms’ headquarters are to plants and whether proximity breeds investment and productivity.”
Combining plant-level data with airline data in the U.S. from 1977–2005, Giroud analyzed how the introduction of new airline routes affected plant investment. It turned out that a new direct route led to an increase in plant investment of 8% to 9%, corresponding to an increase in capital expenditures of $213,000 to $239,000. Further, he found that plants’ total productivity increased by 1.3% to 1.4%, corresponding to an increase in plant profits of $67,000 to $93,000.
In both cases, the effect was only seen when the new route reduced travel time by at least two hours round trip. The larger the reduction in travel time, the stronger the effect.
He also noted that the impact was stronger for plants whose headquarters had fewer managers available to monitor and acquire information about plants. Likewise, the effect was more visible in the earlier years of the sample period when other means of exchanging information such as the Internet, corporate intranets and videoconferencing were less available.
“The increase in investment and productivity is likely a result of an improved ability to gather information and provide monitoring at plants,” says Giroud. “If your managers are very close – or can easily travel to your plant site—then they can learn more about your plant and supervise you more, leading to increased investment and productivity.”
He adds, “The main takeaway from this research for executives is that location matters. My results suggest that, all else being equal, proximity increases the likelihood of investment and is good for productivity.”
Giroud’s paper, Proximity and Investment: Evidence from Plant-Level Data, can be found at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1958200
For more information about Prof. Giroud, please visit: http://sloan.mit.edu/faculty/detail.php?in_spseqno=51410&co_list=F