Over-Investment and Product Market Competition

Abstract

This study uses both theory and empirical evidence to examine over-investment by managers. Based on analytical research, we find that complementary goods are an essential factor contributing to decisions regarding over-investment. Due to the complementarity of goods, an increase in the demand for efficient firms’ products increases the demand for inefficient firms. Efficient firms are then likely to resort to aggressive investments to gain a competitive advantage and improve demand. In addition, we present an empirical case for over-investment by testing the relationship between current year investments and future performance. We introduce a new variable using an analytical model and demonstrate that it impacts managerial investment decision-making. While previous economic theory-based studies frequently applied contract theory to consider managers’ behavior, this study contributes to the literature by indicating that it is also essential to use the industrial organization model. Our study makes the following unique contribution. It proposes a new variable that affects over-investment using the analytical model and demonstrates that it has a significant impact on managers’ decision-making. This finding has an essential contribution to the over-investment literature.