In this paper, we examine the workings of internal capital markets in diversified firms that engage in related and unrelated corporate acquisitions. Our evidence indicates that bidders invest outside their core business (diversify) when the cash flows of their core business fall behind those of their non-core lines of business. However, bidders invest inside their core business (i.e., undertake non-diversifying investments) when their core business experiences superior cash flows. We also find that bidders whose core business are in industries with low growth prospects engage in diversifying acquisitions while bidders whose core business are in high growth industries undertake non-diversifying acquisitions. The pre-acquisition evidence, then, suggests that firms tend to diversify when the cash flows and the growth opportunities of their core business are considerably lower than those of their non-core business. Subsequent to acquisitions we find that diversifying bidders continue to allocate financial resources from less profitable business segments (i.e., core business) to more profitable business segments (i.e., non-core business). Given the low profitability of diversifying bidders’ core business, this capital resource allocation suggests that diversification increases do not result in capital allocation inefficiencies. The evidence for non-diversifying bidders, however, supports the existence of “corporate socialism” in the sense that there is transfer of funds from the profitable (core) to the less profitable (non-core) business segments in multi-segment bidders. We find that the capital expenditures of bidders’ non-core business segments rely on both core and non-core cash flows.

We investigate the predictive power of corporate social culture, as measured by corporate social responsibility (CSR) intensity, on shareholder wealth when mergers and acquisitions (M&As) are carried out by managers with different traits. We find acquiring firms with talented managers are more inclined to engage in CSR activities to shape corporate social culture, thereby realizing larger short- and long-term gains than their counterparts. We also document that acquiring firms with higher levels of CSR commitment led by talented managers tend to acquire targets of similar corporate social culture and experience significantly positive post-merger returns, suggesting that corporate cultural similarity constitutes an important source of M&A synergies. These findings suggest that corporate culture built through stakeholder relations acts as a differentiation strategy that pays off when skilled managers engage in M&As, which typically prompt information asymmetries between managers and outsiders.

This paper examines whether high-ability managers’ earnings smoothing is motivated by the need to mitigate the adverse effects of heightened information asymmetry triggered by mergers and acquisitions (M&As) on managers’ reputation capital (job loss) and firm value. We document that acquirers led by high-ability managers engage in more pre-acquisition earnings smoothing and experience more significant announcement abnormal returns and operating performance in post-M&A periods than their low-ability counterparts. This result is consistent with the theory of managerial response to asymmetric information, amplified by M&As, where high-ability managers use earnings smoothing as a signaling device to ensure that the market quickly discovers their superior abilities, to increase acquirers’ future growth prospects and avoid the adverse effects of information asymmetry on managers’ job security and career prospects in a competitive executive labor market.

This study examines whether risk aversion-inducing CEO compensation motivates managers to pay more dividends regardless of investor preferences. Using inside debt (i.e., pensions and deferred compensation) and the sensitivity of CEO equity compensation to stock price changes (i.e., high CEO delta), as proxies of CEO risk aversion, we document that inside debt induces CEOs to pay dividends while convex CEO compensation decreases dividend payout.

This paper examines the agency conflicts between shareholders and bondholders of multinational and non-multinational firms and provides an explanation for the puzzle that multinational firms use less long-term debt, but more short-term debt than domestic firms. Using a sample of 6951 firm–year observations for multinational and domestic firms over the 1988–1994 period, we find that alternative measures of agency costs have statistically significant negative effects on the firm's long-term leverage. The results, however, also show that the negative effects of agency costs of debt on long-term leverage are significantly greater for multinational than non-multinational firms. It is documented that the effect of the agency costs of debt on leverage are increased by the firm's degree of foreign involvement. The evidence shows that firm's increasing foreign involvement exacerbates agency costs of debt leading to lower (greater) use of long-term (short-term) debt financing. This result is also confirmed using alternative measures of foreign involvement. The evidence is consistent with the view that multinational corporations (MNCs) are susceptible to higher agency costs of debt than domestic corporations because geographic diversity renders active monitoring more difficult and expensive in comparison to domestic firms. The results fail to support the view that MNCs' lower long-term debt ratios are due to the advantages of the internal capital markets.