The effect of financial revenues and net financial payouts on investment efficiency: An investigation of short-termism / Abdul Majid Nasir

Abdul Majid , Nasir (2023) The effect of financial revenues and net financial payouts on investment efficiency: An investigation of short-termism / Abdul Majid Nasir. PhD thesis, Universiti Malaya.

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Abstract

The underinvestment issue remains one of the serious challenges for the non-financial corporations (NFCs) in the United States of America (US). Recent studies claim that NFCs in the US have underinvested compared to the investment opportunities. This underinvestment issue is detrimental to corporate investment efficiency, output growth, long-term cash flows, income distribution and productivity. Hence, drawing from the short-termism theory, the current study investigates whether financial revenues and net financial payouts explain this distortion of investment efficiency and lead to the underinvestment problem. Additionally, this study examines whether earnings benchmarks and stock-based compensation explain the effect of financial revenues and net financial payouts on investment efficiency and underinvestment. This study employs annual panel firm-level data for US NFCs from 1999 to 2018. The current study evaluates the hypotheses through the cumulant and generalized method of moment estimators. The results reveal that financial revenues significantly reduce investment efficiency and lead to higher underinvestment. Conversely, net financial payouts improve investment efficiency and minimize underinvestment. Results also report that earnings benchmarks increase the negative effect of financial revenues and net financial payouts on investment efficiency and intensify the positive effect of financial revenues and net financial payouts on underinvestment. Finally, the results also suggest that stock-based compensation is unable to modify the effect of financial revenues on investment efficiency and underinvestment. Similarly, stock-based compensation does not influence the relationship between net financial payouts and investment efficiency. However, stock-based compensation enhances the positive effect of net financial payouts on underinvestment. Findings of the current study are consistent among high and low uncertain firms, and financially constrained and unconstrained firms. These findings are also robust to reverse causality issue. Overall, the results show that short-termism is one significant factor explaining the underinvestment issue of US NFCs. The implications of this study are of importance to firms, investors and governments, as investment efficiency is a considerable factor that enhances the corporate long-term growth. Firms and investors looking to improve investment efficiency may reinvest the financial revenues on real assets to reduce underinvestment. They may also minimize the net financial payouts in favor of investment efficiency. Moreover, based on the results of this study, analysts may also determine earnings benchmarks, which help achieve both short- and long-term corporate objectives. Besides, shareholders may redesign stock-based compensation to enhance investment efficiency. This study contributes to the existing literature as research on investment efficiency from the perspective of short-termism is still unexplored. Besides, this study develops a single framework explaining the relationship among short-term corporate decisions (financial revenues and net financial payouts), short-term objectives (earnings benchmarks and stock-based compensation) and investment efficiency. This framework helps to understand the simultaneous effect of corporate decisions and corporate short-term objectives on investment efficiency.

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