Study On The Relation Between Managerial Power And Corporate Investment Behavior

Under optimal contracting approach, executive compensation practices are viewed as a mechanism designed to maximize the wealth of shareholders, and minimize the agency costs that exist between executives and shareholders. However, contrary to the optimal contracting approach, managerial power approach, which analyzes from the perspective focuses on the ability of executives to influence their own compensation scheme, points out that compensation arrangements approved by boards often deviate from optimal contracting. Executives have the power to receive compensation in excess of the level that would be optimal for shareholders; this excessive compensation constitutes rents. Executive compensation itself becomes part of agency problem. Investment is an important way to expend the firm size, as the firm size becomes bigger, executives have more control on firm resource, steadier position, and higher compensation. What’s further, investment is by and large non-routine management, which means it needs executives’ judgments. Subjective judgments facilitate executives to gain more private benefits in investment decision. Whether to invest, how to invest, and investment scale, all of these decision processes are more or less influenced by executives, thus, investment activities provide good opportunities to study how executives extract rent via their managerial power.This dissertation focuses on the relation between managerial power and investment behaviors. Investment behaviors are subdivided into three parts: mergers and acquisitions (M&A), diversification, and research and development (R&D). M&A is external investment behavior. Executives can influence the decision of whether to implement M&A, which way to M&A, and M&A scale. When executive compensation is restricted by law or firm institution, executive tend to make more M&A to obtain alternative non-monetary compensation, like controllable resource, promotion, and personal reputation. Diversification could be either external investment or internal investment, or both. Although diversification is a way to expend firm size, its outstanding feature is risk-diversification. It also can gain more benefits from other industries. Thus, risk-aversion executives have motivation to diversify. R&D is totally internal investment behavior, could be influenced easily by executives. R&D is vital for a firm to gain competitive advantage in the market, and is also positive for executives to gain more compensation and promising future. When highly compensated, executives will be motivated to enhance R&D investment to keep compensation in leading level. These three parts of investment behavior from external perspective to internal perspective, reveal a comprehensive view of how managerial power influences investment behavior.It is not only possible, but also feasible that executives influence investment behaviors via managerial power, because investment can bring executives private benefits, and investment also need executives’participation. Previous literature has enormous studies on M&A, diversification, and R&D, and also plenty of literature studies the managerial power and its relation with executive compensation. There is little literature study on the relation between managerial power and investment behavior directly. Investment is an important way to extract rent, so introducing investment to the research domain of managerial power has significance on both of theoretical and practice. The results of this dissertation can also provide some guidance for policy makers to design and modify incentive mechanism, and to supervise executive behavior.The dissertation is composed of seven parts, it is arranged as follows:Chapter1:Introduction. This chapter introduces the research incentives and study background, and the research significance for academia and practice. This chapter also elaborates the research idea and contribution, and draws the outline of the whole study.Chapter2:Literature review. This chapter has a comprehensive review on the foreign and Chinese literature of managerial power and investment behavior. The review will give a panorama of the research frontier in these fields, and facilitates the following studies. Meanwhile, the review also provides literature evidence for the research variables selection and definition.Chapter3:Theoretical analysis and institutional background. This chapter demonstrates three main theories which will be cited frequently in the whole dissertation, they are agency theory, optimal contracting theory and managerial power theory. This chapter also explains the literature how to measure the managerial power and executives how to extract rent through board of directors, compensation committee and compensation consultants. In institutional background, the chapter presents the investment systems reform in China since1979and regulations on mergers and acquisitions in capital market, these backgrounds will provide thorough insight on investment behaviors in China, and provide necessary support for following empirical studies.Chapter4:Managerial power and M&A. This chapter is the empirical research of the influence of managerial power on M&A, executives have incentives to influence the M&A to gain private benefits. First of all, this chapter examines whether executives use managerial power to influence the M&A possibility and M&A scale. This chapter also considers the reality that many executive compensation in State-owned enterprises are restricted by government, under this specific situation, M&A provides a way for executives to gain alternative non-monetary compensation. Lastly, the chapter examines the performance of M&A, to explore the economic consequence of M&A influenced by executives.Chapter5:Managerial power and diversification. Operating in different industries can diversify the firm risk and executives’human capital risk. Diversification is helpful for those recession industries which face the challenge of business transformation. It can also alleviate executives’pressure from occupation and reputation. Executive compensation and perquisite will increase as the firm size increases. Therefore, this chapter examines whether managerial power has positive influence on diversification. When executive compensation is less than industry average level, it means that the profitability of core businesses is bad, this chapter also examines whether managerial power promotes diversification in this situation. Lastly, this chapter tests the relation between firm value and diversification, which is influenced by managerial power.Chapter6:Managerial power and R&D. since R&D is internal investment, executives have more influence on it. R&D can enhance firm’s competitive advantage, thus, R&D has profound influence on firm’s further development and on executive compensation and job stability. This chapter examines whether managerial power can strengthen R&D investment, and then examines the relation between managerial power and R&D under the situation that executives are highly compensated. The value of R&D will be reflected in the product market and securities market, this chapter will also examine whether the influence of managerial power on R&D can improve its value.Chapter7:Conclusions and suggestions. Conclude the theoretical analysis and empirical results in above chapters, and provide some suggestions to improve the regulation on investment behaviors. Finally this chapter makes some comments on the limitations of the dissertation, and gives some clues for further studies.This dissertation adopts empirical method to study the relation between managerial power and investment. Different methods are used for different purpose, for instance, factor analysis is adopted to integrate14managerial power factors to be a comprehensive one variable. Event study is applied to calculate the cumulative abnormal return to measure M&A performance before and after M&A announcement. Linear regression is used to test the linear relation among variables. The research data is collected from CSMAR database, but diversification data is collected from CCER database, I examine those data with the reference of annual reports. Stata11.2is the software used to clear up the data and to analyze the data.The main conclusions of this dissertation are as follows:Managerial power has no significant influence on whether to M&A or not, but has influence on M&A type, the more powerful of executives the higher possibility of local M&A. the State-owned enterprises with compensation restriction are more incline to local M&A, and have larger M&A scale. Influence of managerial power on M&A deteriorates firm value.When shareholders have weak control on firms, executives use use managerial power to make operation more diversified. When compensation is higher than industry average level, executives have more motivation to diversify. Diversification deteriorates firm value; the influence of managerial power on diversification makes firm value worse, but the magnitude is not significant.R&D has profound Influence on competitive advantage and development opportunities, executives have motivation to increase R&D investment. When compensation is higher, it can compensate executives for the short time loss caused by R&D investment, executive could further improve R&D investment to keep the compensation leading level. Product market reacts significantly positively to R&D, managerial power make this more significantly. However, securities market doesn’t react significantly to R&D, even managerial power doesn’t change the situation.The contributions of this dissertation are as follows:This study fills the gap between managerial power and investment, extends the scope of managerial power approach. Now managerial power literature focuses on compensation, while investment, like M&A, diversification, and R&D mainly concern on investment performance, some literature study the factors of investment, but managerial power is not included. Investment is non-routine management, executives can participate deeply in the decision making process. Executives have opportunities to extract rent via investment, study the relation between managerial power and investment could contribute to academia and practice.Both optimal contracting approach and managerial power approach focus on compensation; this dissertation just analyzes the relation between managerial power and corporate investment from the perspective of compensation. When executives are highly compensated, in order to keep compensation in leading level, executives will positively influence investment decision, which is good for shareholder benefits; optimal contracting approach has good explanation on this. When executive compensation is restricted, in order to get alternative non-monetary compensation, executives negatively influence investment decision; managerial power approach has good explanation on this. This dissertation points out that optimal contracting approach and managerial power approach are not substituted, environment will make someone more explainable. This dissertation has contribution to the development of these two theories.This study integrates14managerial power factors into one comprehensive and diversified variable to measure how powerful executives are. Previous literature has two kind of method to measure managerial power, one method is to select different variables to measure managerial power from different perspective. The drawbacks of this method are obvious, how many variables to select is based on subjective judgment, whether those variables selected can well measure managerial power is unknown, if those variables are highly related themselves they can not provide more information. The other modified method is to integrate several factors into one variable, but only3-5factors. Too few factors make the information missing inevitable. This dissertation selects factors from shareholders control, organization influence, executive seniority, executive reputation, and corporate governance. Integrating factors from these5aspects will have more explanation power.