Does product market competition discipline managers? Evidence from an exogenous trade shock and corporate acquisitions

Abstract

AbstractResearch question/issueThis study uses the 1989 Canada‐United States Free Trade Agreement (FTA) to study the effect of increased foreign competition on the efficiency of major corporate investment decisions. The analysis builds on the disciplining theories of competition that suggest that managers facing greater competition should make better investment decisions, resulting in more wealth created for shareholders.Research findings/insightsUsing a sample of more than 2000 mergers and acquisitions, the study finds that acquirers exposed to greater increases in foreign competition experience better acquisition performance. The positive impact of increased competition is stronger in acquirers with relatively higher agency costs prior to the FTA. Managers of acquirers exposed to greater foreign competition are more likely to be terminated following value‐destroying acquisitions.Theoretical/academic implicationsThis study provides novel empirical evidence showing that increased foreign competition results in better investment decisions and that the result is likely due to the disciplining effects of competition. This evidence adds to a growing body of work on the disciplining role of competition and on the effects of increased foreign competition on corporate decision‐making.Practitioner/policy implicationsThis study is relevant to policymakers because the extent of competition can be influenced by policy decisions. For regulators, it is worth considering that reducing import tariffs and other entry barriers into product markets may lower agency costs and increase the efficiency of corporate investment. This is a topical issue due to the increase in globalization and ongoing debates about further liberalization of trade relations.