The Lifecycle of the Firm, Corporate Governance and Investment Performance

Abstract

According to firm lifecycle theory the agency costs of free cash flows are not transitory problems, but are a recurrent issue once firms reach a certain stage in their lifecycle. In particular, as firms mature their cash flows increase substantially while their investment opportunities decline and, to prevent retrenchment, managements need to invest in negative net present value projects. However, too much overinvestment leads to low firm valuation and potentially a hostile takeover. This paper extends firm lifecycle theory by arguing that to neutralize the threat of takeover, managements of maturing firms and their boards of directors progressively deploy antitakeover provisions which allow them to overinvest safely and prevent a decline in the size of their corporations. Firm lifecycle theory is also tested empirically. In this respect, a contribution of this paper is to develop a new empirical index that permits the identification of mature corporations with governance problems due to agency costs of free cash flows. The empirical results show that as firms mature agency costs of free cash flows increase, more antitakeover provisions are put into place and firms invest in projects with returns below their cost of capital.

Does ESG always improve corporate performance? Evidence from firm life cycle perspective

“…Although growth corporates face high financing constraints and weak customer base (Basu and Parker, 2001;Wu et al, 2008), they are usually more innovative and flexible. Investors are more willing to provide financial support to growing corporates to make profits as soon as possible (Saravia, 2014). The ESGP of corporates in the growth stage enhances investors' confidence in them (Hong and Kacperczyk, 2009), and the positive effect of ESGP on the financing ability of corporates is further amplified, which is consistent with the previous study results of Gangi et al, (2020).…”

“…Research by Drempetic et al (2020) also shows that firm size is positively correlated with firm ESGP (Drempetic et al, 2020). However, according to the free cash flow theory, mature companies are prone to over-investment when their financial conditions are relatively relaxed (Jensen, 1986;Triantis, 1994;Saravia, 2014), and the ESG disclosure of corporates may alleviate the agency problem faced by mature corporates.…”