Examining a key corporate role: The influence of capital allocation competency on business unit performance

Abstract

Research on the role of the corporate office in firm performance has focused on establishing how much performance variance can be attributed to a "corporate effect," with little attention devoted to understanding how this influence occurs. In this study, we model capital allocation competency as a dynamic managerial capability and find that lower levels of allocation competency in the form of excess investment to business units with relatively poorer future prospects reduce business unit performance. We also find that market conditions affect performance implications of capital allocation-allocation competency is more salient in more competitive markets. These results enhance our understanding of how the corporate office influences business unit performance through its role in allocating capital across business units.

The Corporate Headquarters in the Contemporary Corporation: Advancing a Multimarket Firm Perspective

“…The estimated corporate effect ranges from 4% (McGahan & Porter, 1997), to 2.7% for a "stable corporate effect" plus 4.6% for specific corporate management decisions (Adner & Helfat, 2003), to somewhere between 8.6% and 12% (McGahan & Porter, 2002). While these studies have primarily attributed this effect to the firm's diversification strategy, scholars have recently pointed out that these corporate effects can also stem from other aspects of corporate strategy and structure, including the CHQ's design and roles (Adner & Helfat, 2003;Arrfelt, Wiseman, McNamara, & Hult, 2014). Therefore, studies that distill the corporate effect into components will contribute to our understanding of the CHQ's impact and offer a more accurate picture of the corporate strategy's impact.…”

Corporate Spin-Offs and Capital Allocation Decisions

“…This research has shown the challenges of efficient capital allocation to be numerous, ranging from agency problems (Scharfstein andStein 2000, Rajan et al 2000) to cognitive distortions (Christensen and Bower 1996, Sull 1999, Gilbert 2001) and even to inefficient comparisons relative to aspiration levels (Arrfelt et al 2013, Arrfelt et al 2015. This study takes these ideas a step further by introducing the possibility that the limit to managerial attention is an additional constraint that could (and appears to) prevent the managers of multi-business firms from allocating capital in an efficient manner to all of the businesses operating in these companies.…”

“…Field research built upon this insight by showing that managers' failure to respond appropriately to the threat of new technologies due to their cognitive biases limits their abilities to allocate capital efficiently within the multi-business firms they run (Christensen and Bower 1996, Sull 1999, Gilbert 2001. Even more recently, studies have productively taken steps towards more precisely unpacking the contingencies in which managers make efficient versus inefficient capital allocation decisions (Khanna andTice 2001, Maksimovic andPhillips 2002), particularly by developing new frameworks that analyze how the tradeoff between growth and profitability influences these decisions (Bardolet et al 2010, Vierreger 2012 and by introducing the ideas of historical and social aspiration levels and how they might affect capital allocation decision-making (Arrfelt et al 2013, Arrfelt et al 2015.…”

“…Chief among these is the capital allocation process, a central strategic function in which the managers of a diversified firm must decide how to divide a pool of financial resources among their business units based on the available investment opportunities (Scharfstein 1998, Ozbas andScharfstein 2009), as well as various social and political considerations within their firms (Scharfstein and Stein 2000, Bardolet et al 2010, Vierreger 2012, Arrfelt et al 2013, Arrfelt et al 2015. Because businesses can only pursue opportunities when they have the financial means to do so, the capital allocation process is a critical mechanism by which firm strategies are enacted.…”

“…Accordingly, After×Median Segment Industry q×Treated represents, for parent firms relative to control firms, the improvement in the efficiency of capital allocation decisions in the post- 5 The construction of this variable and its interpretation as a forward-looking measure of capital allocation efficiency is similar to Gertner et al's (2002) empirical approach. I also attempted to employ the variables and empirical methodology that were developed by Arrfelt et al (2013) and Arrfelt et al (2015) to measure the role of historical and social aspiration levels in capital allocation processes. However, my results using this approach were not statistically significant.…”