Firm Complexity and Investment Inefficiency

Abstract

Drawing on 10-K disclosures to apply a broad measure of firm complexity for a large sample of U.S. publicly listed companies, we document that greater complexity is associated with less efficient investment, manifested in both underinvestment and overinvestment. We examine three potential economic channels underlying this relationship. First, the negative impact of complexity on investment efficiency is more pronounced in firms with weaker corporate governance, consistent with an agency-problem channel in which complexity exacerbates managerial discretion and oversight difficulties. Second, we find no systematic variation in this relation with firms’ financial constraints, suggesting that limited access to external finance does not drive the effect. Third, higher complexity is linked to less accurate management forecasts of earnings per share and capital expenditures, indicating a degraded internal information environment. Consistent with a structural-complexity channel, the complexity–inefficiency relation is stronger in industries where the benefits of investment are inherently harder to predict. Taken together, our findings imply that firms’ inherent organizational and operational complexity undermines investment efficiency primarily by intensifying agency frictions and weakening internal information quality, rather than by tightening financial constraints.

Keywords: firm complexity, investment efficiency, information asymmetry, agency costs, structural complexity

JEL Classification: D25, G30, G32, G38, L11