Corporate governance, investment bandwagons and overcapacity: an analysis of the worldwide petrochemical industry, 1975–95

Abstract

AbstractPrevious research has provided conflicting arguments and evidence on which corporate governance system—bank based or market based—is better in preventing managers from investing in value‐destroying projects. This paper attempts to further the debate by comparing the effect of these different corporate governance systems on preventing capacity expansion bandwagon behavior in the worldwide petrochemical industry in the period 1975–95. Our study shows, first, that neither system is particularly effective in curbing overinvestment; however, the market‐based system seems to be less ineffective than the bank‐based system. Second, free cash flow appears to drive greater bandwagon behavior in the market‐based system than in the bank‐based system. Finally, within the bank‐based system, companies that rely on one bank–shareholder are more likely to join the bandwagon than those with more than one. Copyright © 2003 John Wiley & Sons, Ltd.