Impact of Tobacco Buyout on Manufacturers: Insights from the University of Tennessee Report

1. 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: (865) 974-7407 - fax: (865) 974-7298

2. A P A C Impacts on Manufacturers • TTPP assessments • Future Phase II obligations • Domestic leaf cost savings • Imported leaf cost savings • Responsiveness to future market changes

3. A P A C 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

4. A P A C 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

5. A P A C Assessments

6. A P A C 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

7. A P A C 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

8. A P A C Methodology • Pi,t = current price (value) • di,t+k = expected future cash flow to firm i at time t+k • r = discount rate

9. A P A C 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

10. A P A C 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 = σ2ei • Estimated over the period 200 trading days before the event to 11 days before the event

11. A P A C Methodology • ARi,t = abnormal return for firm i at time t, equal to ei,t

12. A P A C Companies Included

13. A P A C Event Dates • June 14, 2004 • Buyout added to H.R.4520, vote in House W&M 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

14. A P A C Cumulative Abnormal Returns

15. A P A C 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

16. A P A C 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