Agricultural Policy Analysis Center University of Tennessee 310 Morgan Hall Knoxville, TN 379964519

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Tobacco Buyout Impacts on Manufacturers
Kelly Tiller
Agricultural Policy Analysis Center The
University of Tennessee
42nd Tobacco Workers Conference Charleston, South
Carolina January 17, 2006
Agricultural Policy Analysis Center -
University of Tennessee - 310 Morgan Hall -
Knoxville, TN 37996-4519 www.agpolicy.org -
phone [phone] - fax [phone]
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Impacts on Manufacturers

• TTPP assessments
• Future Phase II obligations
• Domestic leaf cost savings
• Imported leaf cost savings
• Responsiveness to future market changes

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Impacts on Manufacturers

• Tobacco manufacturer and importer
  assessments(-10b)
• Domestic leaf cost savings (3.1b to 6.5b)
• Imported leaf cost savings (?)
• Savings for domestic leaf purchases for use in
  international manufacturing operations (?)
• Phase II payment savings (2.1b)
• Responsiveness to future market changes (?)
• Net financial burden 1.3 to 2.7 per pack

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Assessments

• Assessments authorized up to 10.14 billion
  FY2005 through FY2014
• Based on share of sales volume for 6 major
  tobacco product classes
• 158 product manufacturers and 666 product
  importers
• Required to submit data regularly to enable CCC
  to determine respective quarterly shares of
  product classes
• CCC to send quarterly assessment notices the 1st
  of March, June, September, and December
• Assessments due in 30 days

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Assessments
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Market Responsiveness

• Absent the federal tobacco program, U.S. tobacco
  industry can exert more control over the tobacco
  production sector
• Mere existence of former program influenced the
  incentive structure surrounding contracting
• Growers now have a much stronger incentive to
  quickly adjust production, curing, and market
  prep practices to meet customer demands
• Highly beneficial in the event of future FDA
  authority

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Measuring Mfgr Impacts

• Event study methodology
• Predicated upon the efficient markets hypothesis
• All available information is impounded in current
  stock prices
• The value of a firm changes as the result of
  unexpected events that cause investors to revise
  estimates of future cash flows and/or risk
• Calculate a measure of normal returns
• Calculate actual returns around event dates
• Estimate abnormal returns, the difference between
  actual and normal returns

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Methodology

• Pi,t current price (value)
• di,tk expected future cash flow to firm i at
  time tk
• r discount rate

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Methodology

• Ri,t stock returns
• Compare stock returns to a measure of normal
  returns
• Select event dates
• Corresponding to tobacco buyout legislation
  progress
• Lack of information about expected outcome
• Select firms
• Tobacco product manufacturers with complete data
  available on CRSP

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Methodology

• Rm,t value-weighted return on a portfolio of
  all marketable securities at time t
• ei,t error term for firm i at time t expected
  value of zero variance s2ei
• Estimated over the period 200 trading days before
  the event to 11 days before the event

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Methodology

• ARi,t abnormal return for firm i at time t,
  equal to ei,t

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Companies Included
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Event Dates

• June 14, 2004
• Buyout added to H.R.4520, vote in House WM
  Committee
• No FDA, funded by part of tobacco excise tax
  (public )
• July 15, 2004
• JOBS bill passed Senate vote with a buyout intact
• Included FDA, funded by tobacco manufacturers
• October 6, 2004
• H.R. 4520 reported out of conference committee
  WITH the buyout
• October 22, 2004
• President signs JOBS bill, prior to election
• December 23, 2004
• Judge rules in favor of cigarette manufacturers
  on 2004 Phase II payment question

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Cumulative Abnormal Returns
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Summary Conclusions

• No evidence that the buyout negatively affected
  tobacco product manufacturers
• Cumulative impact on expected returns was
  positive, 0.0006, not statistically significant
• Passage of conference report had a negative
  impact, -0.02, significant at 10
• Phase II ruling was statistically significant,
  positive impact, 1.01
• Weak evidence that non-market benefits of
  terminating the tobacco program outweighed net
  economic costs to manufacturers

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Summary Conclusions

• Hypothesized that individual firms may be
  affected differently across event dates
• No statistical evidence found
• The overall legislation (corporate tax overhaul)
  affects some multinational firms simultaneously
  in multiple ways
• May consider alternative event sets
• Excluding signing bill into law
• Pulling out Phase II ruling and doing a separate
  event study on Phase II impacts