Involuntary Corporate Finance: The Influence of Inertia, Industry, Institutions and Firm Attributes on Finance Decisions

Abstract

This article follows the broadening of corporate strategy research from examining the consequences of firm financial decisions to understanding their determinants. It introduces the concept of involuntary corporate finance that is defined as the influences on financial decisions of firms’ inanimate or non-human features, which arise from well-recognized effects, particularly imposed constraints, transaction costs, moral hazard and firm resources. Seven decision examples are chosen for analysis: leverage, payout ratio, change in issued equity, expenditure on capital and R&D, CEO tenure and proportion of CEO compensation at risk. The dataset consists of a panel of 365 manufacturing and retail firms during 2000-2007 which covers the most recent full cycle in the equities market. These sectors enable use of Bureau of Census data for manufacturing and trade firms, and firms have data in Compustat, IBES and Thomson Reuters databases. This provides 31 independent variables, and OLS is used to quantify cause-and-effect links in firm decisions. Financial decisions prove path-dependent, so that prior year’s levels explain an average 30 percent of variation between firms. Causality flows from involuntary factors to firm decisions, and explanatory power is highest for leverage, R&D expenditure and CEO tenure. Involuntary factors explain 30 percent of variation, and are particularly significant to leverage and R&D expenditure. Relationships are economically rational rather than protecting against agency problems. An innovative finding is that fund investors self-limit their property rights when firms perform well, but will exert their influence over management to restrict capital and force firm regeneration when return drops below the industry average. Given that lagged values and involuntary influences together explain an average of 43 percent of variation between firms in financial decisions, agency theory cannot comprehensively explain corporate behavior.