Luận án Three Essays on Strategic Capital Allocation của Carl Henry Vieregger

Washington University in St. Louis Washington University Open Scholarship All Theses and Dissertations (ETDs) Summer 9-2-2013 Three Essays on Strategic Capital Allocation Carl Henry Vieregger Washington University in St. Louis Follow this and additional works at: https://openscholarship.edu/etd Recommended Citation Vieregger, Carl Henry, "Three Essays on Strategic Capital Allocation" (2013). All Theses and Dissertations (ETDs).edu/etd/1160 This Dissertation is brought to you for free and open access by Washington University Open Scholarship.

It has been accepted for inclusion in All Theses and Dissertations (ETDs) by an authorized administrator of Washington University Open Scholarship. For more information, please contact digital@wumail. WASHINGTON UNIVERSITY IN ST. LOUIS Olin Business School Dissertation Examination Committee: Anne Marie Knott, Chair Todd R.

Zenger, Co-chair Nicholas S. Elfenbein Radhakrishnan Gopalan Bruce Petersen Three Essays on Strategic Capital Allocation by Carl Henry Vieregger A dissertation presented to the Graduate School of Arts and Sciences of Washington University in partial fulfillment of the requirements for the degree of Doctor of Philosophy August 2013 St. Louis, Missouri © 2013, Carl Henry Vieregger Table of Contents Acknowledgments iii Dedication iv Do Firms Really Allocate Capital So Inefficiently? 1 Introduction 2 Background and Literature Review 5 Toward a New Measure of Strategic Capital Allocation 12 Methodology 17 Empirical Results 23 Conclusion 26 References 30 Chasing their Tails: Why Do Firms Subsidize Underperforming Business Units 43 Introduction 44 Prior Literature 47 Theory Development 51 Methodology 53 Results 60 Conclusion 66 References 77 Managerial Foresight and Corporate Investment 84 Introduction 85 Setting 86 Empirical Design 89 Descriptive Statistics 91 Multinomial Logit Results 101 Robustness Checks 102 Conclusion 103 References 106 ii Acknowledgements I am extraordinarily thankful to the co-chairs of my dissertation committee, Anne Marie Knott and Todd R. Zenger, for their countless hours of support and counsel—and manuscript edits.

I would not have made it without them. The rest of my committee, comprised of Nicholas S. Elfenbein, Radhakrishnan Gopalan, and Bruce Petersen, in addition to Lamar Pierce, provided invaluable feedback during the entire dissertation process. Many friends and colleagues were also critical to the successful completion of this project.

Tao Ma was a true friend and confidante. Kyle McCawley, Matt Boever, Paul Kramper, and Sam Thompson kept me sane by keeping me on the roads; Jay Greathouse kept me entertained. I was lucky to start the program with Mike McLaughlin and then get to know James Yen, Erin Scott, and Tim Gubler along the way. Sarah Grantham made sure I was always in the right classes, and Tom Fields showed me what great classes look like.

Mike and Deanna Davidson are inspiring friends in so many ways. So are Bill Laird and Ted Warin, who also challenge me in many ways as well. I’m thankful that my brother, Tom Vieregger, and my sister, Kristianne Buechler, will continue to mock my never-ending schooling. Mike and Nancy McCarthy helped support me at the start.

Stephen Penman inspired me to go after the PhD, while John Hughes, John Khabbaz, and Tom Tryforos motivated me to keep one foot in the “real” world. Meanwhile, the staff at Pointers and Sasha’s kept me nourished, and Darren the Cat sat next to me through every draft. I cannot thank my parents, Mary Anne and Hank Vieregger, enough. And finally, a very special thanks to my best friend, Ashlee Minton, who was, well, my best friend through it all.

iii Dedication For my parents, Mary Anne and Hank, who taught me the love of learning… I think I might finally be done with school. iv Do Firms Really Allocate Capital So Inefficiently? Abstract The capital allocation process is a critical component of strategic execution for multidivisional firms. Despite this importance, strategy scholars have ceded much of the empirical work in capital allocation efficiency to the domains of finance and economics. The bulk of this research, as well as evidence from prominent field studies in strategic management, concludes that managers make significantly inefficient capital allocation decisions—a result that should be of concern to business managers and strategy scholars alike.

This paper asks whether managers are truly allocating capital so inefficiently, or do they instead have a valid strategic rationale that explains their investment decisions. Building off the general framework of internal capital market efficiency from financial economics, this paper develops a new measure of strategic capital allocation. The new approach introduces a multidimensional measure to capture the strategic trade-offs between future growth and current profitability, which are faced by managers during the complex resource allocation process. In the first stage of the empirical analysis, managers are found to be allocating capital more than twice as efficiently than prior literature suggests.

The second stage validates this multidimensional approach by demonstrating the predicted theoretical relationship between a strategic measure of capital allocation and firm-level value, namely, that managers appear to be capable of enhancing performance through strategic capital allocation. 1 1 INTRODUCTION The capital allocation process is a critical component of strategic execution. Through the efficient allocation of internal capital resources, top-level managers of the multidivisional firm should be able to enhance firm-level performance (Chandler 1962; Williamson 1975; Stein 1997). Long-term competitive advantage requires them to develop unique combinations of resources through a strategic capital allocation process (Rumelt 1984; Wernerfelt 1984; Dierickx and Cool 1989).

However, the central conclusions from prominent field research (Christensen and Bower 1996; Sull 1999), as well as the bulk of empirical results (Lamont 1997; Shin and Stulz 1998; Rajan, Servaes, and Zingales 2000; Billett and Mauer 2003; Gopalan, Nanda, and Seru 2007; Ozbas and Scharfstein 2010), suggest that the internal allocation of capital is significantly inefficient. While some instances of empirical work do find that multidivisional firms allocate capital efficiently (Khanna and Tice 2001; Maksimovic and Phillips 1998), the prevailing conclusion (Stein 2003) is that agency costs distort the resource allocation process within internal capital markets (Scharfstein and Stein 2000; Rajan et al. In the strategic management literature, recent research by Bardolet, Fox, and Lovallo (2011) also concludes that firms are inefficiently allocating capital among their business units, primarily due to naïve behavioral biases (Bromiley 1986; Barney and Zajac 1994; Gilbert 2001; Garbuio, King, and Lovallo 2011). Given the critical link between resource allocation and strategy, the high and persistent levels of inefficient capital allocation documented in the literature should be of concern to business managers and strategy scholars alike.

A concrete example from Billett and Mauer (2003) highlights the concern: the authors find that multidivisional firms efficiently allocate capital among only 25% of their operating segments; i., firms appear to be destroying value 2 through inefficient capital allocation decisions as much as 75% of the time. This paper asks whether managers are truly allocating capital so inefficiently, or do they instead have a valid strategic rationale that explains their investment decisions. As suggested by the bulk of evidence cited above, strategy scholars have ceded much of the empirical work in capital allocation efficiency to the domains of finance and economics.1 The interdisciplinary approach in this paper thus extends the general framework of internal capital market efficiency from financial economics (Berger and Ofek 1995; Rajan et al. 2000; Billett and Mauer 2003) to provide new insights into what I define as strategic capital allocation.

In the first stage of the empirical analysis I evaluate the efficiency of internal capital markets from a strategic perspective and compare it to the traditional approach from the extant literature. In contrast to prior work that relies on uni-dimensional measures (see Sections 2 and 3 for more detail), I develop a multidimensional measure of capital allocation efficiency to capture the strategic trade-offs between current profitability and future growth (Marris 1963; Marris 1964; Williamson 1964), which are faced by managers during the complex process of resource allocation (Bower 1970; Burgelman 1983). As previously noted, research by Billett and Mauer (2003) finds that firms are allocating capital efficiently among only 25% of their segments, and I replicate those results within a longer sample period from 1979 to 2009. Then, using the multidimensional measure of strategic capital allocation proposed in this paper, I find that firms are efficiently allocating capital 53% of the time, more than twice as often than prior literature suggests.

The validity of any new measure depends on its ability to systematically predict the expected relationships of the underlying theory (Venkatraman and Grant 1986), therefore the 1 An exception in the strategy literature is the work by Bardolet et al. In the introduction to their empirical analysis, the authors remark, “Given the important role capital allocation plays in business strategy, it is surprising that this topic has received relatively little attention in the empirical strategy literature” (Bardolet et al. 3 second stage of the analysis attempts to validate the new, multidimensional measure of strategic capital allocation.2 If the measure truly captures the strategic trade-offs faced by managers during the complex resource allocation process, these capital allocation decisions should enhance firm value. To validate this expected theoretical relationship, I calculate the value-added from internal capital market allocations (Rajan et al.

2000; Peyer 2002; Billett and Mauer 2003) and test its association with proxies of firm-level performance. Consistent with extant literature, value-added based on the uni-dimensional measure of internal capital market efficiency shows an insignificant (and sometimes negative) association with performance.3 On the other hand, value- added from the strategic measure of capital allocation shows a positive and significant association in all tests, and the results are robust for up to five years following the resource allocation decision. These results validate the new, multidimensional measure of capital allocation efficiency—firms appear to be capable of enhancing performance through strategic capital allocation. This paper makes two important contributions.

First, the paper investigates a fundamental component of strategic management theory and practice—the efficiency of a firm’s internal capital allocation processes—that has been largely neglected by strategy scholars of late. The internal capital market of the firm is a fundamental component strategic performance. The 2 In this context, Peter (1979) defines validity as “the degree to which instruments truly measure the constructs they are intended to measure.” Construct validity tests, for example, have traditionally been carried out in the strategy literature for firm-level diversification measures (Lubatkin, Merchant, and Srinivasan 1993) and more recently for business unit-level relatedness measures (Bryce and Winter 2009). 3 The insignificant and negative associations are consistent with prior work showing a diversification discount for multidivisional firms (Lang and Stulz 1994; Berger and Ofek 1995; Servaes 1996).

While this literature has been criticized for selection and measurement biases (Whited 2001; Campa and Kedia 2002; Graham, Lemmon, and Wolf 2002; Villalonga 2004; Chevalier 2004), research designs that examine the diversification discount both before and after the divestment decisions of multidivisional firms attempt to mitigate these biases (Gertner, Powers, and Scharfstein 2002; Dittmar and Shivdasani 2003; Burch and Nanda 2003; Ahn and Denis 2004). My research avoids this debate because it is not focused on the diversification discount, but on the internal allocation of capital within diversified firms. I am only comparing the efficiency of individual segments within each firm, not the efficiency (or market value, as in the diversification discount) between multidivisional and focused firms. The two strands of research are naturally related in that an inefficient internal capital market is often cited as an explanation for the diversification discount.

4 second contribution is of paramount importance for the practice of strategy: the results in this paper provide insight for managers on how to create value through strategic capital allocation. The remainder of this paper is organized as follows. Section 2 provides a review of internal capital allocation efficiency in the strategic management and financial economics literatures, while Section 3 builds on this review to develop a new measure of strategic capital allocation. In Section 4 I describe the empirical methods, sample definition, and the construction of key variables for the analysis.

Section 5 presents the empirical results, and Section 6 concludes. I also include a discussion of limitations and the significant contributions of this paper in the final section.