The Need for Speed: The Impact of Capital Constraints on Strategic Misconduct

Abstract

Under what conditions do firms engage in strategic misconduct? Why do they undertake actions that increase profitability yet break laws or violate strong norms often with costly consequences for public welfare? The strategic management literature offers two external constraints that might explain these actions. First, firms in highly competitive environments with few options for differentiation turn to strategic misconduct for survival. Second, firms that operate in weak regulatory environments adopt strategic misconduct to overcome market frictions that lack of regulation creates. This paper offers a third explanation – access to affordable financing. Existing research on capital constraints has demonstrated firms benefit greatly from additional capital but has yet to investigate its impact on strategic misconduct. I examine the impact of capital constraints on strategic misconduct in the minibus taxi industry in South Africa. Exploiting a natural experiment in which a financing company changed their interest rates due to nation wide protests, I assess the impact of declining interest rates on over 5000 firms from 2015 to 2020. Using an instrumental variable analysis, I find that firms given lower interest rates decrease strategic misconduct, measured by speeding alerts and aggressiveness with other firms, and are more likely to survive. Exploring potential mechanisms through survey and qualitative analysis, I find suggestive evidence that binding capital constraints and high penalties for default might drive these results. My findings suggest that the reduction of capital constraints for firms under duress might increase both firm survival and public safety presenting implications for how we might approach building sustainable and resilient firms and communities.