On the interaction between energy price and firm size in Indian economy

• Author: Anver C Sadath,Rajesh H Acharya
• Date: 01 September 2016
• Published date: 01 September 2016
• DOI: http://doi.org/10.1111/opec.12080

On the interaction between energy price and

firm size in Indian economy

Rajesh H Acharya* and Anver C Sadath**

*Assistant Professor, School of Management, National Institute of Technology Karnataka, Surathkal

Srinivasanagar Post, Surathkal, Managluru 575025, India. Email: rajeshacharyah@gmail.com

**Assistant Professor, Department of Economics, Central University of Kerala, Tejaswini Hills, Periye Post,

Kasaragod District, Kerala, India. Email: anver.omanoor@gmail.com

Abstract

This paper examines the connection between oil price changes and size of firms listed in Indian

stock market. A three-factor Fama–French model along with oil price variables is estimated using

data from a panel of 1535 firms. Results show that there is a positive relationship between growth

in oil price and stock return. Similarly, the size of the firm is also positively related to stock return.

However, oil price uncertainty shows a negative relationship with stock return. Overall, these

results imply that targeted measures should be put in place by the policy makers to safeguard the

interests of the small and medium size firms in India.

1. Introduction and background

The dynamics of the response of business firms to the changes in the price of energy

resources such as oil is an extensively documented issue in the literature. For instance,

while a strand of research examined the implications of the oil price uncertainty or

changes on the investment of the firms (see for example, Davis and Haltiwanger, 2001;

Edelstein and Kilian, 2007; Lee et al., 2011; Yoon and Ratti, 2011 and Sadath and

Acharya, 2015), another strand of literature has focused on the impact of oil price

changes on the stock markets (see for example, Huang et al.,1996; Jones and Kaul,

1996; Cong et al., 2008; Aloui and Jammazi, 2009; Arouri and Nguyen, 2010) or on the

overall macroeconomic performance of the economy (see for example, Hamilton, 1983,

1996, 2003; Hooker, 1996; Barsky and Kilian, 2004 and Klian and Vigfusson, 2011).

However, scant attention was paid to analyse whether size of the firm has any role in

determining its response to changes in the energy prices such as oil price. In this paper,

therefore, we examine whether size of the firm matters in the formulation of response to

the oil price changes by Indian manufacturing firms.

JEL classification: Q41, L25, G12, C23.

©2016 Organization of the Petroleum Exporting Countries. Published by John Wiley & Sons Ltd, 9600 Garsington

Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.

300

It appears that the size of the firm ought to be regarded as a crucial factor, inter alia,

in determining the response of a firm to changes in the prices of energy resources. As

Sadorsky (2008) observed based on the review of extant literature that impact of energy

price changes is felt more on middle-sized firms compared to small and large firms. This

is due to the fact that larger firms are believed to be equipped to deal with such business

challenges and thereby mitigate negative impacts, whereas, small firms will be flexible

enough to adapt themselves according to the warranty of the situation. Bardazzi et al.

(2015), for instance, in their study about the response of the Italian manufacturing firms

to energy price changes taking into consideration the heterogeneity of firm size argued

that energy resources are substitutes in the low-technology sector and weak comple-

ments in all other sectors. Sahu and Narayana (2011) in their research to understand the

determinants of profitability and energy intensity of Indian manufacturing industries

found a non-linear relationship between profitability and size of the firm indicating an

inverted U-shaped relationship. This indicates that bigger firms and smaller size firms are

less profitable as compared to the medium-sized firms.

Moreover, large firms with greater market power and economies of scale will be more

efficient (Oczkowski and Sharma, 2007; Sadath and Acharya, 2015). This implies that such

firms will be in a position to absorb changes in the prices of intermediary energy inputs and

therefore ensure that increase in the cost of production as a result of short-term aberrations

of energy prices did not affect prices of their output and thereby decrease in the demand. In

other words, large firms will have more flexibility in the use of energy resources compared

to other firms. This kind of reasoning implies that small or medium-sized firms will be hit by

the changes in the price of energy products as they will be unable to absorb prices of their

inputs. Kleijweg et al. (1990) in their analysis of whether large firms have more flexibility

in energy use and thereby reduce the energy cost than small firms in the Dutch

manufacturing sector found that large firms have a relative advantage compared to small

firms in terms of the reduction of the energy cost in the total cost of production.

Likewise, the size of the firm has to be figured in while analysing the efforts of firms to

achieve energy efficiency and thereby tackle the problems of global warming and climate

change caused by the greenhouse gas emission. This aspect is demonstrated by Cost-Cambi

et al. (2015) who found that size is an important varia ble in explaining the energy

efficiency innovations of the firms. Similar results are reported by DeCanio and Watkins

(1998), DeMarchi (2012) and Veugelers (2012). Therefore, there exists a case for an

empirical examination to determine whether the response of firms to changes in energy

prices varies according to their size? Towards this, this study has analysed a panel of Indian

firms by using a dynamic panel data model based on Generalized Method of Moments

(GMM) developed by Arellano and Bond (1991). Results show that there is a positive

relationship between growth in oil prices and stock return. Similarly, size is also positively

related to stock return. However, oil price uncertainly shows a negative relationship with

©2016 Organization of the Petroleum Exporting Countries OPEC Energy Review September 2016

Interaction between energy price and firm size 301