Abstract

This study examines the effect of industry－level product market competition on investment efficiency of a firm. Investment efficiency indicates a situation where there exists neither over－investment nor under－investment. First of all, the level of competition can cause over－investment in two aspects. First, managers’ empire building incentives may be intensified under severe competition. Second, under intense competition, managers may be reluctant to release important information to minimize proprietary costs, which leads to over－investment. On the other hand, the level of competition hinders over－investment, attaining investment efficiency. Competition plays an external governance mechanism which enforces managers to exercise their best efforts not to fall behind in the competition. Also, competition may encourage the spread of information in the capital market, reducing information asymmetry and thereby reducing over－investment. Similar predictions can be applied to the case of under－investment. Severe competition may deter investment if managers stand still to avoid high bankruptcy risk. Also, reduced information disclosure under competition may get rid of investment opportunity itself. On the other hand, if managers do their best not to fall behind in the competition or if they disclose more information to the market under the intense competition, under－investment is unlikely to happen. We test these predictions using firms listed in Korea Stock Exchange over the period from 2002 to 2011. The empirical findings support the unfavorable effect of competition with regard to overinvestment. Specifically, we document that the tendency to over－invest increases for the firms that face intense market competition when firms are likely to over－invest. However, we fail to find any evidence that managers tend to under－invest. These findings suggest that competition may generate negative consequences for managers’ efficient investment decisions. We believe that these findings provide several valuable insights into the negative effect of industry－level competition on the investment efficiency, especially for regulators, managers, and other various outside stakeholders. <Key30)words> Investment efficiency, Competition, Over－(Under－) Investment, External governance

Keywords

• Investment efficiency
• Competition
• Over－(Under－) Investment
• External governance mechanism

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