Two essays on corporate finance under time-varying economic conditions

Abstract

This thesis consists of two essays. The commonality of the essays is that I investigate corporate decisions under time-varying economic conditions. In the first essay, I examine how easy money may trigger competitive myopia and contribute to the investment inefficiency problem of competitive industries. The second essay investigates how economic policy uncertainty affects lobbying initiation decision. For the first essay, studies have shown that firms in competitive industries tend to make inefficient investments, compared to their counterparts in consolidated industries. Who would finance inefficient investments? Is financing part of the investment inefficiency problem? To address these questions, I hypothesize that when credit market sentiment is high, firms in competitive industries rush to take advantage of available easy money for investing and for strengthening their current competitive positions, and overlook the developing risk of overcapacity in their industries, which leads to predictable declines in future cash flow and stock performance. Using excess bond premium to proxy for the availability of easy money, I find evidence consistent with my hypothesis. The predictable declines in cash flow are especially severe for firms that invest more during high credit market sentiment periods. Furthermore, competitive myopia triggered by easy money can explain competitive industries' booms and busts. In contrast, due to barriers to entry, consolidated industries are much less affected by easy money. In sum, my study suggests that financing is part of competitive industries' investment inefficiency problem, and that because of competitive myopia, credit market sentiment is an important predictor for competitive industries' future cash flow, but not for consolidated industries'. In the second essay, I find that economic policy uncertainty (EPU) raises firms' incentives to lobby and access policy information. However, I find that non-lobbying firms are less likely to initiate lobbying during periods of high EPU. I find evidence consistent with my conjecture that lobbying entry barriers increase with EPU. I verify that EPU's negative effect on lobbying initiation arises through the channels of lobbying entry expenses and returns to experience. I further identify two mechanisms regulating these channels: (1) inelastic supply of lobbying services and (2) existing lobbying firms' demand for lobbying services (which increase with EPU). Although these two essays are independent, they both show that time-varying economic conditions significantly affect corporate decisions. I illustrate the difference in corporate behavior by comparing operation activities of competitive and consociated industries in the presence of easy money in the first essay, and lobbying firms' and non-lobbying firms' responses to economic policy uncertainty in the second essay. By studying these differences in corporate decisions under time-varying economic conditions, my essays enhance our understanding of how different types of corporations deal with time-varying economic conditions differently.