The impact of competition on corporate decisions

Abstract

This study investigates the impact of product market competition on firm investment policy, asset prices and examines the sensitivity of bank performance to local housing shock. Chapter 1 explores how product market competition affects a firm's investment horizon. In real business, firms do not operate alone; they compete with rivals in the market for survival. In recent decades, competition has been increasing because of lower barriers to entry, deregulation and innovation. Therefore, it is essential to investigate how firms respond to changes in their environment. The results show that firms reduce their investment horizons in response to increased market competition. This chapter addresses the endogeneity issue between competition and a firm's investment horizon. Further analyses show that "capital market pressure" incentivises managers to reduce a firm's investment horizon, achieving good short-term performance. The findings make important contributions to the literature on corporate investment and market competition.

Chapter 2 explores the influence of product market competition on the asset growth anomaly, which is a pervasive asset pricing anomaly. The asset growth anomaly is the negative relationship between asset growth and future stock returns. A large body of literature has investigated this topic, but there is no consensus on whether the phenomenon is explained by the risk-based hypothesis or the mispricing-based hypothesis. Using product market competition as a control variable combined with a series of methods such as time series, Fama-Macbeth, double sorted portfolio analysis, I find that the asset growth effect is stronger in concentrated industries but weaker in competitive industries. Further evidence indicates that the asset growth anomaly is more pronounced among firms with greater investment discretion. High cash flow firms or low debt ratio firms in concentrated industries show a stronger asset growth anomaly, but I do not observe this in competitive industries. These results support the overinvestment explanation and are inconsistent with the rational explanation. The empirical results underline the role of market competition on asset growth - expected stock returns relationship, which contributes to the literature on dissecting the asset growth anomaly.

Chapter 3 jointly with Nhan Le and Takeshi Yamada, we examine the differential effects of local housing shock on geographically diversified and non-diversified local banks. Contrary to intuition, the operating performance of diversified banks is more sensitive to local housing price shocks than their local counterparts. The difference in the sensitivity is most pronounced in bear housing markets but not in bull markets. Further analysis shows that local banks better manage their loan quality, and diversified banks promote more aggressive risk-taking incentives, reflected in equity, debt policies and CEO compensation. The finding is robust to the endogeneity problems of local housing markets and the geographic diversification strategy of banks.