The Lifecycle of the Firm, Corporate Governance and Investment Performance

Documentos de trabajo Economía y Finanzas No 13-30

40 Pages Posted: 5 Feb 2014

See all articles by Jimmy Saravia

Jimmy Saravia

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF)

Multiple version iconThere are 2 versions of this paper

Date Written: November 1, 2013

Abstract

According to firm lifecycle theory the agency costs of free cash flows are not transitory problems, but are a recurrent issue once firms reach a certain stage in their lifecycle. In particular, as firms mature their cash flows increase substantially while their investment opportunities decline and, to prevent retrenchment, managements need to invest in negative net present value projects. However, too much overinvestment leads to low firm valuation and potentially a hostile takeover. This paper extends firm lifecycle theory by arguing that to neutralize the threat of takeover, managements of maturing firms and their boards of directors progressively deploy antitakeover provisions which allow them to overinvest safely and prevent a decline in the size of their corporations. Firm lifecycle theory is also tested empirically. In this respect, a contribution of this paper is to develop a new empirical index that permits the identification of mature corporations with governance problems due to agency costs of free cash flows. The empirical results show that as firms mature agency costs of free cash flows increase, more antitakeover provisions are put into place and firms invest in projects with returns below their cost of capital.

Keywords: Firm Life Cycle, Free Cash flows, Corporate Governance, Overinvestment

JEL Classification: G31, G34

Suggested Citation

Saravia, Jimmy, The Lifecycle of the Firm, Corporate Governance and Investment Performance (November 1, 2013). Documentos de trabajo Economía y Finanzas No 13-30, Available at SSRN: https://ssrn.com/abstract=2390124 or http://dx.doi.org/10.2139/ssrn.2390124

Jimmy Saravia (Contact Author)

Universidad EAFIT - School of Economics and Finance - Center for Research in Economic & Finance (CIEF) ( email )

Carrera 49 No. 7 South - 50
Bogotá
Colombia

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