This study examines the sensitivity of investments to changes in investment opportunities for

2800 WordsApr 23, 201912 Pages
This study examines the sensitivity of investments to changes in investment opportunities for diversified and single-segment firms. Because investment opportunities are unobservable and because many concerns have been raised about existing proxies, I introduce a new proxy based on financial analysts' estimates. The findings are consistent with the idea that firms respond efficiently to changes in investment opportunities. Specifically, firms increase (decrease) their capital expenditures when there is a favorable (unfavorable) change in opportunities. More importantly, I find that diversified firms are more sensitive to changes in investment opportunities than are single-segment firms. Much of differences in investment behavior between…show more content…
are mainly diversified? Are larger firms consistently following destructive patterns? Or are we mistakenly associating corporate diversification with inefficiency? Most of the empirical studies on internal capital markets set the investment behavior of single firms as a benchmark for diversified firms’ investment behavior and mainly use Tobin’s Q as a proxy for investment opportunities. I argue that this approach leads to misleading conclusions about internal capital markets inefficiency in diversified firms, and I also propose another proxy for investment opportunities based on financial analysts’ estimations. Finance literature documents tendency of CEOs to overinvest above the optimal levels of investment. Jensen (1986, 1993) claims that empire-building CEOs will spend all available resources in investment projects even when it’s not optimal to do so. While Stein (1997) states that the private benefits, CEOs are deriving, increase with the level of resources under their control. Therefore, overinvesting will maximize the private benefits of those CEOs. Another relevant factor that we should consider is managers’ overconfidence; CEOs tend to be overconfident about the prospects of their firms and therefore overinvest as they believe that this optimal decision will maximize shareholders wealth (Heaton 2002). On the other hand, Stulz point out that firms will underinvest when cash flow is low. Due to the information asymmetry between CEOs and shareholders, the

More about This study examines the sensitivity of investments to changes in investment opportunities for

Open Document