Investing in turbulent environments: Implications for strategy and governance

Jonathan P O'Brien, Purdue University

Abstract

This dissertation is comprised of three essays that seek to enlighten the conditions that determine whether investments with highly variable potential payoffs serve as legitimate strategic investments or manifestations of agency problems. The first essay focuses on organizational slack, which may be beneficial to firms attempting to be innovators, but harmful to firms with agency problems. It is argued that exogenous industry uncertainty will magnify both the positive and negative manifestations of slack. Empirical tests confirm that slack is a critical moderator of both investment behavior and firm value for firms attempting to be innovators, and that uncertainty magnifies the value of slack. However, results regarding the potential agency costs of slack did not generally support the hypotheses. The second essay focuses on growth options, which can be an important factor in influencing investment decisions. It is argued that growth options will be most valuable to firms competing on the basis of innovation, and to firms already operating in related industries. However, since it is very difficult to precisely calculate the value of real options, it will be difficult for outsiders to evaluate the wisdom of investments in growth options. Thus, although investments in growth options can potentially have great strategic value, they may also serve as convenient vehicles for over-investment in firms with agency problems. Empirical tests confirm that these firm level characteristics influence not only the probability of investing in growth options, but also the market's reaction to those investments. The third essay argues that growth options will dissuade firms from exiting industries in which they compete. Consistent with the second essay, it is argued that growth options will be more valuable to firms competing on the basis of innovation, and hence these firms will be less inclined to exit an industry with valuable growth options. However, in firms prone to agency problems, managers can easily exaggerate the value of growth options in order to justify remaining in an industry even when exit is warranted. Empirical tests confirm that both of these types of firms are more sensitive to the dissuasive influence of growth options on exit.

Degree

Ph.D.

Advisors

Folta, Purdue University.

Subject Area

Management

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