Does Corporate Governance Matter in Competitive Industries?

Abstract

By reducing the fear of a hostile takeover, business combination (BC) laws weaken corporate governance and create more opportunity for managerial slack. Using the passage of BC laws as a source of identifying variation, we examine if such laws have a different effect on firms in competitive and non-competitive industries. We find that while firms in non-competitive industries experience a substantial drop in operating performance, firms in competitive industries experience virtually no effect. Though consistent with the general notion that competition mitigates managerial agency problems, our results are, in particular, supportive of the stronger Alchian-Friedman-Stigler hypothesis that managerial slack cannot exist, or survive, in competitive industries. When we examine which agency problem competition mitigates, we find evidence in favor of a "quiet-life" hypothesis. While capital expenditures are unaffected by the passage of BC laws, input costs, wages, and overhead costs all increase, and only so in non-competitive industries. We also conduct event studies around the dates of the first newspaper reports about the BC laws. We find that while firms in non-competitive industries experience a significant decline in their stock prices, firms in competitive industries experience a small and insignificant price impact.

Director attention and firm value

“…Although the results in the prior subsection are more in line with the quiet life hypothesis (Bertrand & Mullainathan, ; Giroud & Mueller, ) than with empire building, they do not exclude alternative explanations. Most notably, it may be that managers simply cannot make or implement important decisions such as acquisition deals when it is difficult to schedule meetings with distracted directors for discussion and approval.…”

Does market power discipline CEO power? An agency perspective

“…Dasgupta, Li, and Wang () document that the likelihood of forced CEO turnover and its sensitivity to performance increases with competition shocks induced by tariff cuts. Tang () extends Giroud and Mueller () by highlighting the role of performance correlations. We complement this prior literature by showing how CPS and CEO pay gap , the relative pay within a firm, is affected by PMC and how corporate governance moderates this relationship.…”

“…CEO dominance, on the one hand, is subject to agency costs and thus reduces firm value (Bebchuk et al, ; Chen, Huang, & Wei, ; Khanna et al, ; Liu & Jiraporn, ; Vo & Canil, ). Since PMC serves as an external disciplining mechanism and improves the efficiency of firms (Chhaochharia, Grinstein, Grullon, & Michaely, ; Giroud & Mueller, ), stronger PMC should reduce CEO power. However, on the other hand, the ability to respond fast to market conditions is considered a competitive advantage for firms and granting CEOs more power can reduce the implementation time for corporate decision‐making (Cuñat & Guadalupe, ; Li, Lu, & Phillips, ).…”

“…Bebchuk et al () and Chhaochharia and Grinstein () contend that in the absence of corporate governance, agency problems are more likely to arise and adversely affect firm value. Moreover, Giroud and Mueller () and Chhaochharia et al () show that corporate governance regulations have a greater impact on firms with less competitive product markets.…”

“…Cuñat and Guadalupe () find that a higher level of PMC increases the pay–performance sensitivity of compensation schemes for CEOs. Chhaochharia et al () and Giroud and Mueller () utilize exogenous shocks to corporate governance and find that corporate governance has a stronger positive impact on firm efficiency when the market is more concentrated. Li et al () find that in high demand product markets where firms are facing entry threats, investors react more favorably to the announcements of granting more power to CEOs.…”