The impact of cash flows and firm size on investment: The international evidence

This paper examines the degree to which cash flow availability influences firm investment in six OECD countries. In particular, we are interested in the extent to which the reliance on internal funds is affected by firm size, since there is general agreement that smaller firms have less access to external capital markets and, thus, should be more affected by the availability of internal funds. Earlier work has concluded that the documented positive relationship between cash flow and investment is evidence of the existence of financial constraints. We first examine all firms, regardless of size, in each country, and we find that the amount of corporate investment is affected by internal resources in all six countries; that is, internal financing affects firm investment. We then repeat the analysis segmenting the sample using three measures of firm size. Contrary to our a priori expectations, we find that the cash flow-investment sensitivity is generally highest in the large firm size group and smallest in the small firm size group. We deduce that the explanations for these findings are grounded in managerial agency considerations, and in the greater flexibility enjoyed by large firms in timing their investments. Thus, we conclude that the degree of sensitivity of a firm's investments to its cash flows cannot be interpreted as an accurate measure of its access to capital markets (as do Kaplan, S., Zingales, L., 1997. The Quarterly Journal of Economics 169–215), since small firms are known to have less access to external markets.     

Bank lending incentives and firm investment decisions in China

This study investigates whether and how banks’ lending incentives influence firms’ investment behaviors in China. First, empirical results show that loans granted to politically connected firms are less influenced by those firms’ profitability and tangibility. Second, political connection is a violation factor in debt markets, and our study finds that firms with political ties invest less efficiently than firms without political ties when they can access abnormal debt. Finally, we find that regional development with regard to market development and government quality improvement reduces the negative impact of politically connected lending on firms’ investment efficiency.     

The impact of leverage on firm investment: Canadian evidence

This study examines the impact of financial leverage on the firms' investment decisions using information on Canadian publicly traded companies. It shows that leverage is negatively related to investment and that this negative effect is significantly stronger for firms with low growth opportunities than those with high growth opportunities. The paper tests the robustness of these results using alternative empirical models and, in addition, uses the instrumental variable approach to deal with the endogeneity problem inherent in the relationship between leverage and investment. The results provide support to agency theories of corporate leverage, and especially the theory that leverage has a disciplining role for firms with low growth opportunities.     

The impact of tax incentives on foreign direct investment in China

Scholes and Wolfson 1989, Scholes and Wolfson 1992) argue that tax rules jointly influence investment decisions and organizational form. The present research uses Chinese data to test these assertions. Specifically, our study investigates whether (1) the creation of special tax incentive zones is an effective tax policy for China to induce new foreign direct investment (FDI) into specific regions, and (2) changes in the tax rules influence the particular form of foreign direct investment selected: equity joint ventures, contractual joint ventures, and wholly foreign-owned enterprises. Our results indicate that tax incentives are effective in attracting FDI to China, and moreover, influence the selection of a particular form of FDI. One limitation of our study is that we were unable to completely control for the correlated-omitted-variable problem.     

The impact of firm size on bank debt use

I use a sample of US firms to examine the determinants of the concentration of bank debt in total debt. The results indicate that the factors vary by size of the firm. A small- to medium-sized firm has a high concentration of bank debt when it has a low level of discretionary spending. In contrast, a large firm has a high concentration of bank debt when it is difficult for outsiders to observe. The results support the Diamond [J Polit Econ 99 (1991) 689] reputation view that a firm faces different debt choices as it grows. When evaluating bank regulations, policymakers should consider the importance of the reputation-building services, which a bank provides to businesses.     

CEO excess compensation: The impact of firm size and managerial power

Chief executive officer (CEO) compensation has received a great deal of attention over the past several decades. Critics assert that CEO compensation is “excessive” because it is only weakly linked to firm performance (i.e., managerial rent-extraction). On the other hand, defenders suggest that CEO compensation is “justified” given the incremental shareholder wealth created by CEOs, or that large CEO compensation packages merely reflect labor market forces. Prior research documents that CEO power and firm size are associated with larger compensation, but providing evidence that the larger compensation is excessive (i.e., not economically justified) has proven difficult. For each test firm we identify a potential replacement CEO (i.e., an executive-specific, within-country (US) compensation benchmark) and create an empirical test of excess compensation. We also examine the possibility that excess compensation is conditional upon firm size or CEO power. In spite of an inherent bias against finding excess compensation, the results suggest that the most powerful CEOs receive compensation that is not economically justified. We find no evidence of CEO excess compensation in the largest firms.     

The impact of board size on firm performance: evidence from the UK

We examine the impact of board size on firm performance for a large sample of 2746 UK listed firms over 1981–2002. The UK provides an interesting institutional setting, because UK boards play a weak monitoring role and therefore any negative effect of large board size is likely to reflect the malfunction of the board's advisory rather than monitoring role. We find that board size has a strong negative impact on profitability, Tobin's Q and share returns. This result is robust across econometric models that control for different types of endogeneity. We find no evidence that firm characteristics that determine board size in the UK lead to a more positive board size–firm performance relation. In contrast, we find that the negative relation is strongest for large firms, which tend to have larger boards. Overall, our evidence supports the argument that problems of poor communication and decision-making undermine the effectiveness of large boards.     

Net neutrality and investment incentives

This article analyzes the effects of net neutrality regulation on investment incentives for Internet service providers (ISPs) and content providers (CPs), and their implications for social welfare. Concerning the ISPs' investment incentives, we find that capacity expansion decreases the sale price of the priority right under the discriminatory regime. Thus, contrary to ISPs' claims that net neutrality regulations would have a chilling effect on their incentive to invest, we cannot dismiss the possibility of the opposite. A discriminatory regime can also weaken CPs' investment incentives because of CPs' concern that the ISP would expropriate some of the investment benefits.     

Abnormal investment and firm performance

We find a negative relation between abnormal investment and future stock performance. Such a negative relation is mainly driven by under-investment, not over-investment. Our results are robust to various estimation methods and investment models. Both delayed market reaction and agency issues may lead to the apparently anomalous return predictability of under-investment. First, market investors may not react promptly to the fundamental information contained in under-investment about a firm’s future profitability, asset growth, and financial distress probability. Second, the negative relation between under-investment and future stock returns is more pronounced for firms with lower investor monitoring and higher agency costs.     

Government intervention and firm investment

This paper examines how government intervention affects firms' investment and investment efficiency, focusing on the world's largest economic stimulus package (ESP) during the 2008 global financial crisis period. The RMB four trillion ESP aimed to restore the economy by promoting investment in priority areas. Thus it provided an exogenous shock to firms' investment environment and exacerbated the impact of government intervention on firms' investment and investment efficiency. We use propensity score matching to match government-intervened firms with their controls to reduce the endogeneity issue of government intervention. Our difference-in-differences analysis shows that government-intervened firms invested more than control firms. Further analysis shows that the source of funding for investment was mainly from bank loans rather than internal cash flows. However, the post-investment performance was poor. We find that the investment efficiency of government-intervened firms decreased and government-intervened firms overinvested after the ESP. Our results are robust to alternative model specifications and placebo tests. The findings suggest that government intervention can play a negative role in government-intervened firms.     

The impacts of share pledging on firm investment timing and valuation

This paper applies a model in the real options framework to analyze the impacts of controlling shareholder’s share pledging on corporate investment timing and valuation. We find that the optimal investment timing shows an inverted U-shape with the pledge ratio, indicating that share pledging exacerbates firms’ over-investment and worsens firms’ under-investment. Furthermore, share pledging hurts firms’ option value unless active measures are taken to control the pledging risks. The maintenance requirement can keep controlling shareholder from irrational early investments and protect investors from severe wealth losses. In addition, our work can provide testable empirical implications.     

Delegation and dynamic incentives

Using an agency model, we show how delegation, by generating additional private information, improves dynamic incentives under limited commitment. It circumvents ratchet effects and facilitates the revelation of persistent private information through two effects: a play‐hardball effect, which mitigates an efficient agent's ratchet incentive, and a carrot effect which reduces an inefficient agent's take‐the‐money‐and‐run incentive. Although delegation entails a loss of control, it is optimal when uncertainty about operational efficiency is large. Moreover, delegation is more effective with production complementarity. We also consider different modes of commitment to yield insights into optimal organizational boundaries.     

General-equilibrium effects of investment tax incentives

A new-Keynesian model with a nominal tax system is developed and used to study the macroeconomic effects of temporary tax-based investment incentives. Two claims regarding the effects of these incentives are examined: first that they are overstated in partial-equilibrium frameworks; and second that repeated use of such incentives by policymakers can ultimately be destabilizing. The results contradict the first claim and imply that the second claim is not general. The model is also used to compute the predicted effects of an investment tax incentive that has figured prominently in recent fiscal stimulus packages.     

Tournament incentives,age diversity and firm performance

This study introduces a new dimension, age diversity of non-CEO executives, which moderates the relationship between promotion-based tournament incentives, measured as the pay gap between the CEO and non-CEO executives, and firm performance. For a sample of Chinese listed firms from 2005 to 2015, we find that the tournament incentives for non-CEO executives relate positively to firm performance. This relationship is weaker when non-CEO executives are from different age cohorts, whereas the tournament effect is enhanced when non-CEO executives are from the same age cohort. The negative moderation effect of age diversity is more pronounced in state firms and in the Northern China Plain cultural region. The negative moderation effect disappears in firms with CEOs who have overseas experience. We reason that the peer pressure among the similar-aged non-CEO executives enhances the tournament competition and that age hierarchy reduces incentives for younger executives to compete. Our findings have important implications for firms not only in China, but also in countries and regions where seniority is highly valued when setting executive compensation and optimizing organizational structure.     

The influence of financial and legal institutions on firm size

Theory does not predict an unambiguous relationship between a country’s financial and legal institutions and firm size. Using data on the largest industrial firms for 44 countries, we find that firm size is positively related to financial intermediary development, the efficiency of the legal system and property rights protection. We do not find any evidence that firms are larger in order to internalize the functions of the banking system or to compensate for the general inefficiency of the legal system.     

The impact of geographic diversification on firm performance

This paper empirically examines the economic effects of both corporate industrial and geographic diversifications. Using a sample of 28,050 firm-year observations from 1990 to 1998, we find that industrial and geographic diversifications are associated with firm value decrease. Consistent with Denis et al. [Denis, D. J., Denis, D. K., and Yost, K. (2002). Global diversification, industrial diversification, and firm value. Journal of Finance, 57, 1951-1979], the costs of corporate diversification may outweigh the benefits of diversification. We find that geographically diversified firms have higher R&D expenditures, advertising expenses, operating income, ROE and ROA than industrially diversified firms. In addition, higher R&D expenditures create value for multi-segment global firms, but not for single-segment global firms. This result implies that there exists an interaction effect between industrial and geographic diversification. We also examine the effects of agency cost issues, as characterized by the diversification discount, on both industrial and geographic diversification. Consistent with the agency explanation, firms with high equity-based compensation are associated with higher firm value than firms with low equity-based compensation. Also, we find that firms with a higher insider ownership percentage are associated with higher excess value.     

The impact of firm prestige on executive compensation

We show that chief executive officers (CEOs) of prestigious firms earn less. Total compensation is on average 8% lower for firms listed in Fortune’s ranking of America’s most admired companies. We suggest that CEOs are willing to trade off status and career benefits from working for a publicly admired company against additional monetary compensation. Our identification strategy is based on matched sample analyses, difference-in-differences regressions, and a regression discontinuity design. We perform several robustness checks and exclude many alternative explanations, including that firm prestige just proxies for better corporate governance or for increased exposure of the pay-setting process to media attention.     

Uncertainty,investment, and managerial incentives

This study provides evidence that managerial incentives, shaped by compensation contracts, help to explain the empirical relationship between uncertainty and investment. We develop a model in which the manager, compensated with an equity-based contract, makes investment decisions for a firm that faces time-varying volatility. The contract creates incentives that affect both the sign and magnitude of a manager׳s optimal response to volatility shocks. The model is calibrated using compensation data to quantify this predicted investment response for a large panel of firms. Our estimates help explain the variation in firm-level investment responses to volatility shocks observed in the data.     

The role of investment banks on the impact of firm performance in mergers and acquisitions: evidence from the Asia-Pacific market

This study uses a comprehensive sample of 5271 bidders during the period of 1995–2011 to examine the role of financial advisors on the outcomes of mergers and acquisitions in the Asia Pacific market. The results indicate that bidders take more time to complete deals when hiring tier-3 advisors. In addition, the empirical evidence indicates that bidders obtain higher announcement returns when hiring low reputation financial advisors. The results are robust when controlling for year effects, country effects and self-selection bias. In addition, the regression analysis also reveals that bidders obtain lower post-announcement returns when hiring tier-1 advisors in domestic deals. Thus, the empirical findings illustrate the importance of the quality of financial advisors on firm performance in mergers and acquisitions in the Asia Pacific market.     

Tournament incentives, firm risk, and corporate policies

This paper tests the proposition that higher tournament incentives will result in greater risk-taking by senior managers in order to increase their chance of promotion to the rank of CEO. Measuring tournament incentives as the pay gap between the CEO and the next layer of senior managers, we find a significantly positive relation between firm risk and tournament incentives. Further, we find that greater tournament incentives lead to higher R&D intensity, firm focus, and leverage, but lower capital expenditures intensity. Our results support the hypothesis that option-like features of intra-organizational CEO promotion tournaments provide incentives to senior executives to increase firm risk by following riskier policies. Finally, the compensation levels and structures of executives of financial institutions have received a great deal of scrutiny after the financial crisis. In a separate examination of financial firms, we again find a significantly positive relation between firm risk and tournament incentives.