Competitive pressure and firm investment efficiency: Evidence from corporate employment decisions

• Published date: 01 January 2022
• Author: Sabri Boubaker,Viet A. Dang,Syrine Sassi
• Date: 01 January 2022
• DOI: http://doi.org/10.1111/eufm.12335

DOI: 10.1111/eufm.12335

ORIGINAL ARTICLE

Competitive pressure and firm investment

efficiency: Evidence from corporate

employment decisions

Sabri Boubaker

1,2

|Viet A. Dang

3

|Syrine Sassi

4

1

EM Normandie Business School, Métis

Lab, France

2

International School, Vietnam National

University, Hanoi, Vietnam

3

Alliance Manchester Business School,

University of Manchester,

Manchester, UK

4

Economics, Energy & Policy

Department, Paris School of Business

(PSB), Paris, France

Correspondence

Viet A. Dang, Alliance Manchester

Business School, University of

Manchester, Booth St. West, Manchester

M15 6PB, UK.

Email: vietanh.dang@manchester.ac.uk

Abstract

This study examines the link between product market

competition and labour investment efficiency. We find

that competitive pressure distorts the efficiency of

corporate employment decisions by creating an un-

derinvestment problem. This finding withstands a

battery of robustness checks and remains unchanged

after accounting for endogeneity concerns. Additional

analysis shows that the relationship between product

market competition and labour investment efficiency is

stronger for firms facing higher competitive threats,

greater financial constraints, higher information

asymmetry and higher labour adjustment costs.

Our results suggest that as competition increases

Eur Financ Manag. 2022;28:113–161. wileyonlinelibrary.com/journal/eufm

|

113

EUROPEAN

FINANCIAL MANAGEMENT

This is an open access article under the terms of the Creative Commons Attribution‐NonCommercial‐NoDerivs License, which permits

use and distribution in any medium, provided the original work is properly cited, the use is non‐commercial and no modifications or

adaptations are made.

© 2021 The Authors. European Financial Management published by John Wiley & Sons Ltd

We would like to thank John A. Doukas (the editor) and two anonymous referees for their helpful comments and

suggestions that have greatly improved our paper. We also acknowledge the helpful comments from Najah Attig,

Hamdi Driss, Christophe Faugère, Iraj Fooladi, Sadok El Ghoul, Jean‐François Gajewski, Omrane Guedhami, Yi Jiang,

Ambrus Kecskés, Kim Cuong Ly, Simona Mateut, Xiaoran Ni, Marc Steffen Rapp, Walid Saffar, Anita Suurlaht, Vu

Tran, Vineet Upreti, David Yermack and Achraf Zaman. Our paper has also benefited from valuable feedback from

participants at the 25th Annual Conference of the Multinational Finance Society in 2018, World Finance Conference in

2018, 9th International Research Meeting in Business and Management in 2018, 4th International Conference on

Banking and Finance Perspectives in 2019, FMA European Conference in 2019, INFINITI Conference on International

Finance in 2019, Vietnam International Conference in Finance in 2019, Asia‐Pacific Management Accounting Asso-

ciation (APMAA) 15th Annual Conference in 2019, as well as finance research seminars at the University of Swansea,

Brunel University, Kedge Business School, University of Lyon, Dalhousie University, Portsmouth University, Open

University and Coventry University. The usual disclaimer applies.

bankruptcy risk, it leads managers to underinvest in

labour to avoid incurring labour‐related costs.

KEYWORDS

import tariffs, investment efficiency, labour investment,

product market competition, risk exposure

JEL CLASSIFICATION

G31, G34, G38, M51

1|INTRODUCTION

Understanding the determinants of corporate investment decisions has long been a central

issue in corporate finance research. Since the irrelevance theorem of Modigliani and Miller

(1958), an important stream of literature has shown that, under less restrictive capital

market assumptions, firm real investment is relevant and is affected by various factors; see

Hubbard (1998)andStein(2003) for comprehensive literature reviews. Recently, a growing

number of studies highlight the role of product market characteristics in shaping firm

investment policies and asset returns (e.g., Aguerrevere, 2009;Gu,2016;Stoughtonetal.,

2017). Following substantial changes in the U.S. competitive landscape,

1

some research

focuses on how product market competition influences corporate investment. However,

most of this literature examines firm investments in capital expenditure, research and

development (R&D) and innovation (e.g., Akdoğu & MacKay, 2012;Frésard&Valta,2016;

Jiang et al., 2015). There is surprisingly little work on the effects of competition on firm

investment in labour, an equally important factor of production. Indeed, labour‐related

costs exceed two‐thirds of the economy‐wide value added (Jung et al., 2014)andrepresenta

significant portion of total production costs. For example, the U.S. Census Bureau's Annual

Survey of Manufacturers shows that payroll and employee benefits in the manufacturing

sector amounted to about $840 billion in 2017, relative to $169 billion in capital ex-

penditures.

2

More importantly, human capital is considered an asset vital to firms, parti-

cularly to those operating in competitive and rapidly changing environments. Zingales

(2000, p. 1642) remarks that ‘[…] increased competition at the worldwide level has increased

the demand for process innovation and quality improvement, which can only be generated

by talented employees’.

The present paper addresses this void in the literature by investigating the implications

of product market competition for labour investment efficiency. The rationale behind our

research question is twofold. First, although recent studies highlight the prominent role

of product market competition in shaping firm R&D and capital investment decisions,

the results and conclusions of such studies cannot be used to infer the impact on labour

investment decisions. This is because capital and labour investments differ with respect

to their adjustment costs, which represent an important driver of firm investment

1

Many factors have contributed to changes in the U.S. competitive environment, including antitrust laws, deregulatory

initiatives, import competition and economic globalization (e.g., Bloom et al., 2016; Irvine & Pontiff, 2009).

2

These statistics are from https://www.census.gov/programs-surveys/asm/data/tables.html.

114

|

EUROPEAN

FINANCIAL MANAGEMENT

BOUBAKER ET AL.

strategies.

3

Accordingly, the greater the difference between labour adjustment costs (LACs)

and capital adjustment costs (CACs), the greater the difference in the impact of competition

on labour and capital investment.

4

In addition, labour markets are highly regulated and

strongly coordinated, making it costly for companies to undertake employment adjustments

(Matsa, 2018). For example, many U.S. states have passed minimum wage laws and em-

ployment protection regulations, increasing the costs of hiring and retaining employees.

Second, labour investment presents unique characteristics that make it more subject to

market frictions, leading to more inefficient behaviour. As an intangible asset, labour invest-

ment is hard to monitor as it often falls within the discretion of managers. Accordingly, it is

characterized by more managerial private information than capital investment,

5

making it

easier for managers to deviate from the optimal level of investment to the detriment of

shareholder interests. To the extent that investment in labour requires high input costs, such as

wages, costs of hiring, training, retaining and firing (e.g., Dube et al., 2010), managers may be

reluctant to engage in costly labour‐related activity, creating a potential underinvestment

problem in labour. These arguments underscore the unique characteristics of labour and the

importance of extending the literature by considering the impact of competition on firm em-

ployment decisions.

We develop and examine two competing views on the relation between product market

competition and labour investment efficiency. The first view, known as the ‘bright side’of

product market competition, suggests that competitive pressure improves labour investment

efficiency. The argument behind this conjecture is that competition acts as an effective tool to

discipline managers and alleviate the divergence of interests between managers and share-

holders (e.g., Hart, 1983; Nalebuff & Stiglitz, 1983; Schmidt, 1997). According to agency theory,

such a divergence of interests is considered the major cause of inefficient management beha-

viour, which can take the form of empire‐building through overinvestment or effort aversion

through underinvestment (e.g., Jensen & Meckling, 1976; Jensen, 1986). Specifically, firm

overinvestment in labour is reflected in either overhiring by expanding the number of staff

beyond its optimal level or underfiring by retaining an unproductive workforce (e.g., Ghaly

et al., 2020). Underinvestment in labour can also be caused by manager preference for the

‘quiet life’and reluctance to expand investment in labour (Bertrand & Mullainathan, 2003),

which results in an underhiring or overfiring problem. On the basis of the disciplinary effect of

competition, we expect firms facing stiffer competitive pressures to undertake more efficient

labour investment.

In contrast, the alternative view suggests that competitive pressure in the product market is

negatively associated with labour investment efficiency due to the ‘dark side’of competition.

This view predicts that firms facing greater product market competition may either underinvest

or overinvest in labour, following two different mechanisms. First, to the extent that compe-

tition impinges on a firm's expected profits (e.g., Tirole, 2010) and exposes the firm to risk of

3

The literature on investment dynamics shows that corporate investments respond slowly to shocks, such as un-

certainty shocks, due to factor adjustment costs. However, LACs appear to be substantially lower than CACs (e.g.,

Bloom, 2009; Shapiro, 1986).

4

In additional analysis (see our online Supporting Information Appendix and Table S5), we provide empirical support

for the argument that the difference between LACs and CACs leads to a more pronounced effect of competition on

labour investment.

5

Rampini and Viswanathan (2013) further explain that investment decisions in physical assets suffer less from agency

and information asymmetry problems, due to the availability of more detailed information about such assets, which

makes it harder for managers to hide opportunistic behaviour.

BOUBAKER ET AL.EUROPEAN

FINANCIAL MANAGEMENT

|

115