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 overinvest, whereas firms following an efficiency-orientated defender strategy are more likely to underinvest. 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-effect, first-differenced specification, and propensity score matching.

Keywords: Business Strategy, Over-investment, Under-investment, Managerial Compensation