Does competition exacerbate investment inefficiencies? Evidence from Japanese firms

Abstract

This paper investigates the implications of product market competition for the efficiency of managerial investment decisions. Using a sample of Japanese public corporations, we find that competition in the product market leads to overinvestment. We attribute this finding to the deleterious effects of competition on agency costs. Our hypothesis is supported by the fact that these adverse effects become more severe in environments with high agency costs, i.e., those with cross-shareholdings and interlocking business relationships, often referred to as Keiretsus, and those with weaker corporate governance arrangements. Our results are robust to the inclusion of firm-level characteristics, empirical specifications, and endogeneity of competition. Overall, our findings shed light on an important channel through which competition induces overinvestment namely, agency costs.