ESSAYS ON CORPORATE INVESTMENT

Abstract

This dissertation is comprised of three essays on corporate investment. The first essay, titled "What If the Firm Does Not Diversify? A Self-Selection Free Bayesian Approach", takes a comprehensive look at the diversification discount. By employing a switching regression model with the Bayesian data augmentation methodology, I compare the actual post-acquisition firm value of diversifying acquirers to the counter-factual alternative which is a non-diversifying acquisition. I find that there is a considerable amount of acquirers that could improve their value by diversifying acquisitions more than what they would improve by non-diversifying acquisitions. When there are negative shocks to the acquirers' primary industries, when these industries are concentrated and the firms are not dominant players in the industries, diversifying acquisitions add values to the firms. The firm-by-firm analysis shows that on average, no diversification discount exists. The next two essays study U.S. manufacturing firms' outsourcing activity, using a unique dataset of purchase obligations from firm 10-Ks. The second essay is titled "Outsourcing and Firm Financial Structure", and the third essay is titled "Firm Risk Taking versus CEO Diversification: Evidence from Outsourcing Firms". In the second essay, I explore the outsourcing decision and its implications on firm investment and capital structure. I first examine what kinds of firms use external contracts to provide a product or service as a major input to their production. I find that relatively young or large firms with a large number of patents are more likely to use external purchase contracts. Within high-technology industries, firms with purchase contracts tend to have higher R&D investment, while in low- technology industries, firms with purchase contracts are more likely to enter new markets. Outsourcing activity has important risk and capital structure implications, as firms that outsource have significantly less leverage. These results are consistent with outsourcing being used by firms to improve their flexibility. Faced with this increased firm flexibility and fewer fixed assets to pledge as collateral, outsourcing firms finance their operations proportionally more with equity. In the third essay, I examine CEO compensation in outsourcing firms. I find that the intensity of outsourcing can significantly explain the variations in CEO compensation; the more the firms do outsourcing, the more they pay to their CEOs. Outsourcing firms promote managerial risk-taking by using proportionally more equity-based compensation. However, they also need to compensate additionally their CEOs for the higher risk exposure to the firms' increased total risks. I show that outsourcing firms determine their compensation level and structure based on this optimal trade-off.