Business Strategy, Over- (Under-) Investment, and Managerial Compensation

Abstract

This study examines whether and how business strategy influences a firm's over- and under-investment decisions. Prospector and defender strategies expose firms to different required levels of investment, monitoring, and managerial discretion, which have implications for managerial investment decisions. Our results provide evidence that firms with an innovation-orientated prospector strategy are more likely to over-invest, whereas firms following an efficiency-orientated defender strategy are more likely to under-invest. These over- and under-investments are associated with poorer future firm performance. Moreover, the level of over- (under-) investment is exacerbated in the presence of more stock- (cash-) based compensation in prospector (defender) firms. Our results are robust to a number of checks such as ordered logit analysis, individual components of business strategy, individual components of investment, year-by-year and industry-by-industry analysis, controlling for lagged investment residuals, controlling for firm fixed-effects, first-differenced specifications, and propensity score matching.

Business strategies and annual report readability

“…Prospectors are also more likely to receive a going‐concern audit opinion (Chen et al ., ) while less likely to remediate material weaknesses (Bentley‐Goode et al ., 2017b). Furthermore, managers of firms with prospector business strategies are often compensated through stock options, and this encourages managers to pursue inefficient overinvestment (empire building) in an attempt to boost stock price (Navissi et al ., ). The management obfuscation hypothesis suggests that, when managers fail to deliver the expected performance, they tend to obfuscate this failure by making annual reports less readable (Li, ).…”

“…Our study fills this gap in the literature. We also contribute to the organisation strategy literature that shows that business strategy affects the information environment, audit reporting quality, investment and managerial compensation, tax avoidance propensity and stock price crash risk (Bentley et al ., ; Higgins et al ., ; Bentley‐Goode et al ., ,b; Chen et al ., ; Habib and Hasan, ; Navissi et al ., ). We provide new insights into the determinants of annual report readability by documenting that firm‐level business strategies explain cross‐sectional differences in readability, even after controlling for the known determinants of annual report readability.…”

Business strategy and sustainable development: Evidence from China

“…Business strategy, which firms adopt to respond to external environment changes and gain competitive advantages (Porter, 1996), has great effect on enterprise decision making (Chen, Eshleman, & Soileau, 2016; Habib & Hasan, 2019; Habib, Hasan, & Segot, 2017; Hambrick, 1983; Higgins, Omer, & Phillips, 2015; Navissi, Sridharan, Khedmati, Lim, & Evdokimov, 2017; Simons, 1987). From the perspective of business strategy, the existing literature explains the differentiation of firm's environmental protection and sustainable development behaviors; however, there is no consensus reached.…”

Board compensation and disclosure quality: corporate governance interference

“…Sufficient information disclosure by firms helps users in finding suitable investment positions, and as a result, capital flows to the most productive firms. Navissi et al (2016) examined the impact of various business strategies on managers' compensation and investment decisions. They showed that defensive or active strategies lead to different kinds of decisions, monitoring and investment level which have an impact on the managers' decisions and their bonuses.…”