تئوری سوسیالیستی بازار سرمایه داخلی
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Publisher : Elsevier - Science Direct (الزویر - ساینس دایرکت)
Journal : Journal of Financial Economics, Volume 80, Issue 3, June 2006, Pages 485–509
We develop a model of a two-division firm in which the “strong” division has, on average, higher quality investment opportunities than the “weak” division. We show that, in the presence of agency and information problems, optimal effort incentives are less powerful and thus managerial effort is lower in the strong division. This leads the firm to bias its project selection policy against the strong division. The selection bias is more severe when there is a larger spread in the average quality of investment opportunities between the two divisions.
A vast majority of corporate investment is financed with internal funds.1 Since investment decisions made using internal funds are not subject to the same scrutiny from the external capital markets as those funded with new equity or debt issues, it is important to examine how effectively internal capital markets allocate funds to their best use. Although this research question is difficult to tackle directly, the availability of data on investments by major business lines (segments) of U.S. public companies allows researchers to compare investment decisions in conglomerate firms against investment decisions in focused firms. The related empirical literature typically shows that investment in one division of a conglomerate firm is sensitive to the cash flows of unrelated divisions and that conglomerate firms invest less in divisions from industries with good investment opportunities and more in divisions from industries with poor investment opportunities compared to their focused counterparts (see, e.g., Lamont, 1997, Scharfstein, 1998, Shin and Stulz, 1998, Rajan et al., 2000 and Gertner et al., 2002).2 Moreover, the empirical literature finds that this socialistic behavior is more severe when there is more diversity in the quality of investment opportunities across divisions in the firm (Rajan et al., 2000, Lamont and Polk, 2002 and Billett and Mauer, 2003).3 These empirical observations are difficult to reconcile with agency models at the level of the CEO. For example, if the CEO has empire-building preferences, such models would predict overinvestment in all divisions instead of a reallocation of funds from strong to weak divisions. Accordingly, two recent models go a level deeper into a firm's hierarchy and focus on the role of rent-seeking activity by division managers. First, Scharfstein and Stein (2000) develop a model in which managers divert their time away from productive effort to enhance their outside options and increase their bargaining power when negotiating total compensation. The authors argue that such behavior is more problematic with respect to managers of weak divisions because the opportunity cost of being unproductive is relatively low for them. One way to mitigate this problem is to offer the manager a cash payment to refrain from such behavior. However, Scharfstein and Stein suggest that if there is another layer of agency between the CEO and shareholders, the CEO may prefer to distort investment in favor of the weak division rather than increase cash payments to the manager because the latter comes from discretionary funds (which the CEO can control and potentially divert to himself) rather than investment funds (which are assumed to be under the control of shareholders). One problem with this explanation is that it seems implausible that CEOs would prefer to misallocate potentially hundreds of millions of investment dollars in order to maintain discretion over a relatively small cash payment to the division manager. Second, Rajan et al. (2000) develop a model in which division managers have autonomy to choose between an efficient investment and a “defensive” investment that protects their division's surplus from being appropriated by other managers. Thus, while the efficient investment maximizes firm value, a manager may prefer the defensive investment particularly when the surplus created is far greater than that in other divisions. The firm can mitigate this inefficiency by tilting the capital budget in favor of the division with lower-quality investments. A key feature of both these models is that the firm cannot write managerial incentive contracts based on the project cash flows. If even crude contracts could be written, the rent-seeking behavior in these models would likely be mitigated at a much lower cost than by tilting the capital budget. In this paper, we develop a model in which a firm invests too much (little) in weak (strong) divisions relative to first-best even when it can write managerial compensation contracts based on division cash flows. Our firm consists of two divisions, such that each has a single investment project. The two projects have the same initial cost and the firm has enough capital to fund only one of them. Each division is run by a manager with private information about the project's quality who can enhance project cash flows by exerting unverifiable and noncontractible effort. The firm selects which project to fund based on analyses (or “reports”) provided by the division managers. We show that the firm increases the likelihood that a project is selected and compensates the (winning) manager with more performance pay and less salary when she reports a higher quality project. This mechanism induces truthful reporting because the greater performance pay obtained from reporting a higher project quality is sufficient to compensate the manager of a high quality project but insufficient to compensate the manager of a low quality project for the reduction in salary. Our main result is that the firm does not necessarily choose the highest quality project. Instead, the firm optimally biases project choice in favor of the weak division: specifically, the strong division's project is chosen only when its reported (and, in equilibrium, true) quality exceeds the weaker division's project quality by a positive premium. The key to understanding this result is that, for any fixed project quality, the cost of providing incentive pay while maintaining truthful reporting is increasing in the proportion of projects of higher quality. This makes the cost of providing effort incentives higher when the division's investment opportunities have higher average quality, which in turn results in lower incentive pay and lower managerial effort in the strong division.4 Thus, since cash flows depend on both project quality and managerial effort, the strong division's project must be of sufficiently higher quality to offset the lower level of managerial effort. The spread in managerial effort widens when the spread in average investment quality widens. We therefore also predict that the bias in favor of the weak division is more severe when the spread between the ex ante quality of investments in the two divisions is greater. This is consistent with the empirical evidence that socialistic cross-subsidization is more pronounced when there is a greater spread in the industry Tobin's-qq across divisions (Rajan et al., 2000 and Lamont and Polk, 2002). The bias in favor of the weak division also increases when the firm is less effective at monitoring the managers’ actions. This is consistent with the empirical evidence that cross-subsidization is more pronounced when firms have ineffective boards of directors (Palia, 1999) and when the CEO has poorly aligned incentives (Scharfstein, 1998). We also show that when the two divisions share the same average project quality but they differ in terms of the uncertainty about project quality, the firm biases project selection against the division with more uncertainty. Thus, we argue that idiosyncratic risk may be relevant for project evaluation not because it affects the appropriate discount rate—all our agents are risk neutral—but instead because it affects equilibrium incentives for managerial effort. Finally, a division manager's compensation depends on the attributes of the other divisions in the firm; for example, expected compensation and performance pay is greater for division managers in low-growth businesses when the other divisions in the firm are in high-growth businesses.5 Beyond the theoretical and empirical literature on internal capital markets that we describe above, our paper is also related to the literature that examines mechanisms for solving agency and information problems in the capital budgeting process. Harris and Raviv, 1996 and Harris and Raviv, 1998 focus on the role of monitoring; Holmstrom and Ricart i Costa (1986) and Ozbas (2005) focus on the role of reputation; and Berkovitch and Israel (2004), Bernardo et al., 2001 and Bernardo et al., 2004, and Garcia (2002) focus on the role of managerial compensation. Our model is most closely related to Bernardo et al. (2001), which examines optimal investment and managerial compensation in a single-division firm in the presence of asymmetric information and moral hazard, and Bernardo et al. (2004), which extends this analysis to the case of a multidivision firm with technological and informational spillovers across divisions. Laffont and Tirole, 1986 and Laffont and Tirole, 1993 examine the related problem of regulating a monopoly with unobserved efficiency (asymmetric information) and noncontractible effort to lower costs (moral hazard). However, in the above models, there is no heterogeneity across agents; in this paper, in contrast, we are concerned about the degree to which firms bias the investment selection process and design compensation to mitigate agency and information problems when there is heterogeneity in the quality of investment opportunities across divisions. Our paper is also related to work by Myerson (1981) and McAfee and McMillan (1989) that shows in an optimal auction with heterogeneous bidders, the seller rationally biases against bidders with higher average valuations to get them to bid more aggressively. In these models, the auction is not ex post efficient, i.e., the winner is not necessarily the bidder with the highest valuation. These and other auction models have asymmetric information but no moral hazard. In our model, the presence of moral hazard leads to interesting implications about managerial compensation contracts. In particular, the design of managerial compensation contracts forms an integral part of the investment process, with the result that the firm's investment selection policy is ex post efficient, i.e., given the equilibrium managerial efforts, the firm chooses the investment that maximizes expected cash flows net of compensation costs. Our model also differs substantially from the auction literature because we can derive numerous implications for the composition of managerial compensation contracts. The remainder of the paper is organized as follows. Section 2 presents our model. Section 3 derives the first-best allocation and the optimal second-best mechanism in the case in which the two divisions’ distributions of project quality have the same variance but different means. We derive implications for project selection bias, hurdle project qualities, and division manager compensation. Section 4 considers the case in which the two divisions’ distributions of project quality have the same mean but different variances. Section 5 concludes and provides direction for future research.
نتیجه گیری انگلیسی
In this paper, we develop a model of a two-division firm in which the optimal effort incentives to division managers with private information about project quality are less powerful in the division with higher quality investment opportunities. This leads the firm to bias its project selection policy against the strong division to offset the lower level of managerial effort. The selection bias is more severe when there is a larger spread in average project quality between the two divisions. One important advantage of our model over competing theoretical models of socialistic internal capital markets based on managerial rent-seeking behavior (Scharfstein and Stein, 2000 and Rajan et al., 2000) is that we derive our results under the plausible assumption that firms can write managerial compensation contracts based on division cash flows. While our model makes several similar predictions to the above competing theories, we make numerous novel testable predictions about the severity of the bias in internal capital markets, the effect of idiosyncratic risk on project evaluation, and the form of managerial compensation. In our model, firm scope is given exogenously but in reality it is determined by considering the various costs and benefits of integration. For example, the benefits of integration include the slackening of financial constraints (e.g., Billett and Mauer, 2003) and the possibility that the CEO may be better informed about the firm's investment opportunities than the external capital market (e.g., Stein, 1997), while the costs of integration include the diversion of managerial talent, higher influence costs within the organization, and weaker incentives to improve the firm's investment opportunity set (e.g., Brusco and Panunzi, 2005). In future research, we hope to endogenize firm scope to obtain a fuller understanding of observed differences in investment policy across conglomerate and focused firms.