Free cash flow problem and empire building. Managers maximize their own utility. If they have discretion over a large amount of cash flow they will overinvest. Disciplinary device to mitigate this problem is debt. Interest payments will reduce the available free cash flow.
If managers optimize firm size they may overinvest and therefore accept negative NPV projects. When debt is increased accepting negative NPV projects will lead to bankruptcy which is not in the managers interest. This is an important benefit of debt financing.Definition
Amihud & Lev (1981)
Managers invest in diversification. They do so to reduce firm risk and therefore increase their job security.Definition
Shleifer & Vishny (1989)
Managers invest in projects that need their specific human capital to secure their positions in the firm. Managers have greater bargaining power when they are difficult to replace.Definition
McConnell and Muscarella (1985)Term
Find a significant positive (negative) announcement effect for firms announcing capital expenditure (investment) increases (decreases).
Moeller, Schlingemann and Stulz (2005)Term
Study the value effects of acquisition. They find a large amount of value destruction measured by cumulative abnormal (dollar) returns around acquisition announcements.
Attig et al. (2012)
In the presence of long-horizon investors (institutional investors), investment to cash flow sensitivity is reduced. The argument is that in the presence of long-horizon investors, firm monitoring is increased and more effective. This mitigates agency costs (information asymmetry) and therefore reduces the information costs of attracting external finance.Definition