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Strong shareholder rights, internal capital allocation efficiency, and the moderating role of market competition and external financing needs

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Abstract

This study investigates the effect of strong shareholder rights on the internal capital allocation efficiency of multi-segment firms and how market competition and the firm’s need for external financing moderate this association. For this purpose, we use panel data from North American multi-segment firms covering the years 1998 through 2006 with dynamic firm fixed effect models, which enable us to control for unobserved and time-invariant firm heterogeneity as well as for a dynamic nature of the internal capital allocation process. We confirm previous findings of Chen and Chen (J Bank Finance 36(2):395–409, 2012) and show that strong shareholder rights significantly increase the internal capital allocation efficiency. Further, we find that market competition moderates this association by significantly weakening this positive effect. However, the moderating effect of external financing needs is not found to be significant. These findings indicate that strong shareholder rights are crucial for ensuring efficient internal capital allocations within multi-segment firms, especially when market competition is low.

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Notes

  1. Here we argue from the agency perspective that greater managerial discretion makes value-destroying investment decisions of the corporate manager more likely to occur. We acknowledge, however, that the stewardship perspective (Davis et al. 1997) implies that managerial discretion can also lead to more efficient internal capital allocations.

  2. E-Index data are available on http://www.law.harvard.edu/faculty/bebchuk/data.shtml.

  3. Here, we assume that the CEO, as the controlling entity of the firm, has the final say in the capital allocation process and, thus, solely his characteristics are likely to determine the internal capital allocation efficiency. In fact, the internal capital allocation decision process is characterized by a more complex interplay among different entities within the firm (e.g., other entities than the CEO are the CFO and business unit manager; for an overview see Bower 1986). However, not least because of a lack of relevant data and the opaqueness of this interplay, we find it reasonable to limit our investigations to CEO characteristics.

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Authors and Affiliations

  1. Business Management Group, University of Muenster, Georgskommende 26, 48143, Muenster, Germany

    Maximilian Sturm

  2. Chair of Business Management, University of Muenster, Georgskommende 26, 48143, Muenster, Germany

    Stephan Nüesch

Authors
  1. Maximilian Sturm
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  2. Stephan Nüesch
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Correspondence to Maximilian Sturm.

Appendix

Appendix

See Table 3.

Table 3 Results of OLS estimation with firm-clustered robust standard errors and internal capital allocation efficiency as dependent variable with a 1-year time lagging structure of the right-hand variables and up to five time lags of past internal capital allocation efficiency
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Sturm, M., Nüesch, S. Strong shareholder rights, internal capital allocation efficiency, and the moderating role of market competition and external financing needs. Rev Manag Sci 13, 93–111 (2019). https://doi.org/10.1007/s11846-017-0244-1

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