Business Strategy, Over - (Under)

JOURNAL OF MANAGEMENT ACCOUNTING RESEARCH American Accounting Association
Vol. 29, No. 2 DOI: 10.2308/jmar-51537

Summer 2017
pp. 63–86
Business Strategy, Over- (Under-) Investment,

and Managerial Compensation
Farshid Navissi
Monash University
VG Sridharan
Deakin University
Mehdi Khedmati
Edwin KiaYang Lim
Egor Evdokimov
Monash University
ABSTRACT: This study examines whether and how business strategy influences a firm’s over- and under-
investment decisions. Prospector and defender strategies expose firms to different required levels of investment,
monitoring, and managerial discretion, which have implications for managerial investment decisions. Our results
provide evidence that firms with an innovation-orientated prospector strategy are more likely to over-invest,
whereas firms following an efficiency-orientated defender strategy are more likely to under-invest. These over- and
under-investments are associated with poorer future firm performance. Moreover, the level of over- (under-)
investment is exacerbated in the presence of more stock- (cash-) based compensation in prospector (defender)
firms. Our results are robust to a number of checks such as ordered logit analysis, individual components of
business strategy, individual components of investment, year-by-year and industry-by-industry analysis,
controlling for lagged investment residuals, controlling for firm fixed-effects, first-differenced specifications, and
propensity score matching.
Keywords: business strategy; over- (under-) investment; compensation.
INTRODUCTION
ur study examines the association between business strategy1 and over- or under-investment2 and whether managerial
O stock- or cash-based compensation plays a role in such an association.3 A central question in management and
accounting research is whether and how a firm’s business strategy may incentivize managers to act inconsistent with
shareholders’ interests. Prior research has employed a composite measure of firm business strategy, defined in terms of Miles
Editor’s note: Accepted by Ranjani Krishnan.

Submitted: December 2014
Accepted: June 2016
Published Online: July 2016
1
In this study, we focus on two extreme types of business strategy in Miles and Snow (1978); namely, prospector, which adopts an innovation strategy,
and defender, which adopts an efficiency strategy. Analyzer, the third type of business strategy, is used as a reference group since it portrays
characteristics of defender and prospector. We do not consider reactor, which is the fourth type of business strategy in Miles and Snow (1978). Reactor
is not a viable strategy since it fails to achieve a strategic fit. Further, the business strategy measure we employ is based on the methodology of Bentley,
Omer, and Sharp (2013), which has only captured the prospector, analyzer, and defender strategies.
2
While the existing literature employs the term ‘‘inefficient investment’’ (e.g., Biddle, Hilary, and Verdi 2009), we use the terms ‘‘sub-optimal
investment,’’ ‘‘over- and under-investment,’’ and ‘‘inefficient investment’’ interchangeably.
3
Although the optimal contracting theory suggests that executive compensation is a mechanism to align managerial interests with shareholders’ interests
(Holmström 1979; Jensen and Meckling 1976 ), the design and complexity of executive compensation contracts can influence managerial risk attitude
and behavior and hence do not always unambiguously lead to optimal firm outcomes (Denis, Hanouna, and Sarin 2006; Devers, McNamara, Wiseman,
and Arrfelt 2008). For example, Holmström and Milgrom (1991) illustrate that a compensation contract sensitive to the performance of one task may
result in sub-optimal effort devoted to other tasks that are not easily measurable.
63
Business
64 Strategy, Over- (Under-) Investment, and Managerial Compensation Navissi, Sridharan, Khedmati, Lim, and Evdokimov
64
and Snow’s (1978) innovation-orientated prospector and efficiency-orientated defender strategies, to document that firms
adopting a prospector business strategy invest in risky high growth projects and are faced with greater agency problems
(Rajagopalan 1997 ) and, therefore, display more financial reporting irregularity that requires greater audit effort (Bentley et al.
2013). Moreover, other studies show that a prospector firm engages in aggressive tax avoidance strategies (Higgins, Omer, and
Phillips 2015). Arguably, the greater managerial discretion (Boyd and Salamin 2001) and less stringent monitoring (Bentley et
al. 2013) in a prospector strategy cultivate the environment for such a managerial self-serving attitude that may lead to over-
investment. In contrast, a defender strategy provides less managerial discretion (Thomas and Ramaswamy 1996 ) and more
stringent monitoring (Bentley et al. 2013), motivating managers to reduce their career-related risks by under-investing in high
return but risky projects. Nevertheless, the association between business strategy and capital investment, and whether such an
association is influenced by stock- or cash-based compensation has not been addressed by prior literature. Our study attempts to
fill such a gap in the literature.
Given that a business strategy dictates the firm level of capital investment (Miles and Snow 1978), prospector and defender
managers may have the opportunity and incentives to engage in sub-optimal investment projects that maximize their own
interests to the detriment of shareholders. Since a firm’s business strategy is sticky, and changing the strategy requires
considerable changes to the way a firm conducts its business in achieving its goals (Hambrick 1983; Snow and Hambrick
1980), it is imperative to understand managerial incentives based on firm business strategy. Bentley et al. (2013) report that
prospectors are associated with lower-quality financial reporting, and Biddle et al. (2009) find that lower financial reporting
quality leads to inefficient investment decisions. The combined evidence from the above studies may suggest that business
strategy, rather than financial reporting quality, is an antecedent of sub-optimal investment decisions, the issue that we
investigate in our study.
Prior studies show that higher stock- and options-based compensation is likely to encourage managerial risk taking
behavior, increasing stock return volatility and the value of stock option portfolios (Armstrong and Vashishtha 2012; Coles,
Daniel, and Naveen 2006; Rego and Wilson 2012). Other studies suggest that managerial risk-taking behavior, motivated by
higher equity incentives, intensifies agency conflicts between managers and external stakeholders (Armstrong, Gow, and
Larcker 2013; Brockman, Ma, and Ye 2015; Chen, Greene, and Owers 2015). Since prospectors tend to reward their managers
with equity and options-based compensation (Rajagopalan 1997 ), it is likely that prospector managers commit to significantly
higher levels of sub-optimal investments to induce stock return volatility and thus maximize their compensation. In support,
Francis, Huang, Rajgopal, and Zang (2008) and Malmendier and Tate (2009) find that reputable CEOs who have higher stock-
based pay sensitivities are associated with poorer earnings quality and exhibit a stronger rent-seeking incentive that ultimately
reduces the quality of financial reports. On the other hand, managers in the defender strategy, who tend to receive cash-based
compensation (Rajagopalan and Finkelstein 1992; Rajagopalan 1997 ), may refrain from investing in positive but risky
investment projects to enhance their current compensation.
We are motivated to investigate the link between business strategy and managerial over- and under-investment for several
reasons. First, responding to Biddle et al. (2009), who call for research to examine the causal link between financial reporting
quality and investment efficiency, we introduce business strategy as a first-order effect. This is also consistent with Zahra,
Priem, and Rasheed (2005), who call for research in accounting to focus more on direct causes or antecedents rather than
investigating the secondary effects. Second, the potential role that compensation may play in such an association motivates our
study. Third, the economic scale of investment outlays provides further motivation to examine the source of over- and under-
investment. For example, gross business investment, which stood at U.S. $1.31 trillion at the end of calendar year 2010, is now
projected to reach U.S. $2.23 trillion at the end of 2020 (Byun and Frey 2012).
Based on a sample of 36,007 firm-years from 2000 to 2009, our main results support the hypotheses that the likelihood of
over-investment—relative to normal (expected) investment—is significantly associated with prospector strategy, and the
likelihood of under-investment—relative to normal (expected) investment—is significantly associated with defender strategy.
We find that these over- and under-investments are associated with poorer future firm performance. We also find that (1)
prospector managers with higher stock-based compensation over-invest to a greater degree, and (2) defender managers with
higher cash-based compensation under-invest to a greater extent. In more robust analyses, we estimate two binary logistic
models to test our hypotheses in prospector and defender firms, separately. Results from this analysis suggest that in the
subsample of prospector firms associated with over-investment, the over-investment is more pronounced for prospector firms
closer to the upper end of the prospector strategy scores; whereas in the subsample of defender firms associated with under-
investment, the under-investment is more pronounced for defender firms closer to the lower end of the defender strategy scores.
In additional analyses, we control for other potential determinants of sub-optimal investment including two measures of CEO
overconfidence, internal control material weaknesses, and overall firm risk, and continue to report consistent results. Our results
Journal of Management Accounting Research Journal of Management Accounting Research

Volume 29, Number 2, 2017 Volume 29, Number 2, 2017
Business
65
are also robust to a number of checks such as analyses of individual components of business strategy, analyses of individual
components of investment, ordered logit regression, and year-by-year and industry-by-industry analyses. We also address the

Business
66
endogeneity issue by controlling for a lagged dependent variable (investment residuals), and with first-differenced regression
specifications, firm fixed-effects, and propensity score matching.
By employing an integrative approach that draws several streams of literature together, namely business strategy,
investment decisions, and managerial compensation, our study makes the following contributions. First, we provide a better
understanding of how managers may misuse the discretion given to them under different business strategies. While discretion is
an integral part of some business strategies (e.g., prospector) that facilitates creativity, we suggest that the remuneration
committees review compensation contracts to better motivate managers to act consistent with shareholders’ interests. Second,
we contribute to the growing stream of research that examines various firm outcomes in the context of business strategy,
including Bentley et al. (2013), Bentley, Omer, and Twedt (2014 ), and Higgins et al. (2015), and also to the investment
efficiency stream of literature (e.g., Biddle et al. 2009; Chen, Hope, Li, and Wang 2011; Cheng, Dhaliwal, and Zhang 2013).
Third, our results, in particular, contribute to the corporate governance literature by suggesting that organizations characterized
by prospector strategy may have a heightened risk of information asymmetry, which leads to over-investment decisions. While
we do not interpret our findings as suggesting that firms with a prospector strategy should reduce the discretion available to
their managers, we document an important setting in which prospector managers use such discretion to act in a self-serving
manner. Finally, our results contribute to investors’ better understanding of how they may vary their price-protection decisions
with business strategy types.
The remainder of this study is organized as follows. In the next section, we discuss related literature and develop our
hypotheses. The third section details the methodology, measurements, and data. We describe our sample and present
descriptive statistics and main results in the fourth and fifth sections, respectively. The sixth section discusses additional
analyses and the seventh section reports the results from robustness checks, and we conclude the study in the final section.
RELATED LITERATURE AND HYPOTHESES DEVELOPMENT
Investment Decisions
According to the neo-classical framework, capital investments are assessed based on the marginal Q ratio, which represents
whether the marginal benefit exceeds the marginal cost of investment (Abel 1983; Biddle et al. 2009; Hayashi 1982;
Yoshikawa 1980) conditional on the adjustment costs for new capital installation. Additionally, investments in positive net
present value (NPV ) projects require external financing, and after meeting the related interest payments managers must return
excess cash to investors. While Modigliani and Miller (1958) suggest that firms can always sustain optimal investment levels in
a perfect market, other studies argue that market frictions can influence investment efficiency, including financial resources
(Myers 1977 ) and agency conflicts (Hubbard 1998; Jensen 1986; Shleifer and Vishny 1989).
Biddle et al. (2009) ‘‘conceptually define a firm as investing efficiently if it undertakes projects with positive NPV under
the scenario of no market frictions such as adverse selection or agency costs. Thus, under-investment includes passing up
investment opportunities that would have positive NPV in the absence of adverse selection. Correspondingly [they define]
over-investment as investing in projects with negative NPV.’’ Literature on under-investment argues that risk-averse managers
who are concerned about their career may shirk by rejecting value-enhancing projects or avoiding risky but optimal investment
projects, if they perceive that such projects will place their own personal welfare at risk (Shavell 1979; Lambert 1986 ).
Conversely, by over-investing, managers expand their firms beyond optimal size (i.e., empire building) to gain more power and
benefits from perks (Aggarwal and Samwick 2006; Blanchard, Lopez-de-Silanes, and Shleifer 1994; Stulz 1990; Yermack
2006 ). Jensen (1986 ) suggests that self-serving executives, bestowed with free cash flow, will invest in negative NPV projects
rather than paying out dividends to shareholders, leading to sub-optimal over-investment.
Business Strategy
The Miles and Snow (1978) strategic typology has been employed in recent studies that link business strategy to firm
outcomes, including financial reporting quality (Bentley et al. 2013) and tax avoidance (Higgins et al. 2015). Miles and Snow
(1978) argue that firms employ one of the three essential viable strategies of prospector, defender, or analyzer by adopting
different patterns of product markets, technology, and organizational structure and processes to remain competitive in the
market.4 A firm’s business strategy dictates, through prospector or defender strategies, the strategic investment direction of the

Business
67
4
In this study, we focus on the discussion surrounding the prospector and defender strategies. The discussion on analyzer is sparing. This is because it
exhibits both characteristics of defenders and prospectors, despite varying in the degree of focus on innovation and efficiency (Miles and Snow 1978).
We use analyzer as a reference group that is more likely to invest more efficiently compared to its two extreme strategy counterparts.

Business
68
firm and also affects the level of managerial discretion and information asymmetry, which in turn can influence investment
decisions.
Prospector Strategy
Prospector strategy provides more discretion to managers since it is characterized by the pursuit of a first-to-market and
innovation strategy that requires investments in multiple new technologies to afford the design of new products and exploration
of new product markets (Conant, Mokwa, and Varadarajan 1990; McDaniel and Kolari 1987 ). The employment of several
technologies concurrently, with varied levels of sophistication, requires the hiring of highly skilled employees who in turn must
be provided with extensive discretion to optimize the use of technologies (Fox-Wolfgramm, Boal, and Hunt 1998; Gomez-
Mejia 1992; Gomez-Mejia, Welbourne, and Wiseman 2000; Naiker, Navissi, and Sridharan 2008). Due to the emphasis on
exploring novel ideas and aggressive strategies, it is difficult to program managerial behaviors in a setting that confers
significant latitude (Rajagopalan and Finkelstein 1992).
A prospector business strategy, which requires intensive investments, can cultivate the environment for managers to over-
invest (i.e., empire building) in negative NPV projects because it offers considerable decision-making discretion to managers
(Ittner, Larcker, and Rajan 1997; Miles and Snow 1978), with loosely defined procedures and performance assessments (Miles
and Snow 2003; Naiker et al. 2008). Such high discretion and lack of defined performance assessment give rise to uncertainty
about managerial performance (Aboody and Lev 2000; Barth, Kasznik, and McNichols 2001; Huddart and Ke 2007 ).
Prospectors may utilize this opportunity to over-invest in negative NPV projects to grow firms beyond their optimal size (Hart
and Moore 1995; Jensen 1986 ). Myers and Majluf (1984 ) show that information asymmetry leads to inefficient investment
decisions, and since investors perceive capital projects as an indication of higher future cash flows and enhanced firm value
(Graham and Frankenberger 2000; McConnell and Muscarella 1985), prospector managers may be motivated to over-invest in
order to maximize stock price performance (Bizjak, Brickley, and Coles 1993). It is, therefore, possible that more managerial
discretion, less stringent monitoring (Miles and Snow 1978; Thomas and Ramaswamy 1996 ), and the larger investment
requirements (Hambrick 1983; Sabherwal and Chan 2001; Snow and Hrebiniak 1980) in prospector firms incentivize the
managers to over-invest in negative NPV projects.
Moreover, it is possible that prospector managers over-invest to earn more compensation, since Rajagopalan (1997 ) shows
that compensation in the prospector strategy tends to be stock based, and Eisdorfer, Giaccotto, and White (2013) provide
evidence that managers with stock-based compensation engage in over-investment. Although managers may be aware that sub-
optimal investment decisions may lead to their firms’ future under-performance, studies such as Cheng (2004 ), Hirshleifer
(1993), and Lundstrum (2002) show that managers have a myopic view of firm performance, and are prepared to incur future
cost to the firm in exchange for immediate personal gains. Furthermore, prior studies show that managerial risk taking increases
with the level of stock- and options-based compensation, which can increase stock return volatility (Armstrong and Vashishtha
2012; Coles et al. 2006; Rego and Wilson 2012) thereby exacerbating agency conflicts between managers and external
stakeholders (Armstrong et al. 2013; Brockman et al. 2015; Chen et al. 2015). Francis et al. (2008) and Malmendier and Tate
(2009) associate reputable CEOs who have higher stock-based pay sensitivities with poorer earnings quality and a stronger
rent-seeking incentive, which ultimately compromise the quality of financial reports.
Formally stated:
H1: Prospector business strategy is more likely to be associated with over-investment.
H2: The likelihood of over-investment associated with the prospector business strategy is more pronounced when
managers have a higher level of stock-based compensation.
Defender Strategy
To maximize production efficiency, defenders continually focus on strengthening both technical and administrative
capabilities within their chosen technology (Hambrick 2003; Mengüç and Auh 2008). Hambrick (2003) argues that defenders’
staying power is not just due to their continuous improvement of the efficiency of their technology use, but also their ability to
stay clear of unrelated technological investments, which suggests a lower level of investment in a defender, relative to a
prospector, strategy. Defender firms offer considerably lower managerial discretion by imposing strict rules and procedures in
their business operations to reduce risk taking (Miles and Snow 1978; Thomas and Ramaswamy 1996 ), motivating managers to
decline risky (although positive) NPV projects. It is, therefore, easier to conceal under-investment in a defender strategy since

Business
69
defenders typically require fewer and smaller investments (Cho and Hambrick 2006; Snow and Hrebiniak 1980; Kabanoff and
Brown 2008). Moreover, Bentley et al. (2014 ) state that defender firms have lower analyst and media coverage, and less

Business
70
frequent voluntary disclosures, which suggests that, with the reduced quantity of information, investors are less able to evaluate
whether the defender managers have appropriately invested or deliberately under-invested the firm’s resources.
Lower levels of managerial discretion, more stringent monitoring (Miles and Snow 1978; Thomas and Ramaswamy
1996 ), and the fewer investment requirements (Cho and Hambrick 2006; Snow and Hrebiniak 1980) in defender firms
incentivize the managers to focus on investing in projects that increase current earnings and, hence, under-invest in long-
term positive NPV projects. Moreover, since Rajagopalan and Finkelstein (1992) and Rajagopalan (1997 ) find that defender
firms tend to adopt a cash-based compensation structure, it is possible that defender managers give priority to short-term
profitable projects and therefore under-invest in potentially profitable long-term projects to secure higher levels of current
compensation.
Formally stated:
H3: Defender business strategy is more likely to be associated with under-investment.
H4: The likelihood of under-investment associated with the defender business strategy is more pronounced when
managers have a higher level of cash-based compensation.
METHODOLOGY, MEASUREMENTS, AND DATA
Methodology
In this section, we directly model whether higher (lower) scores of business strategy are associated with the higher
likelihood that a firm over- (under-) invests. Similar to Biddle et al. (2009),5 we employ a multinomial logistic regression
framework Model (1) to test whether the likelihood of over- or under-investment is associated with our test variable, business
strategy (OS). More specifically, we examine whether the likelihood of over-investment (INVEFF ¼ 2) is associated with higher
scores of OS ( prospector strategy), and the likelihood of under-investment (INVEFF ¼ 1) is associated with lower scores of OS
(defender strategy). In this framework, the normal investment (INVEFF ¼ 0) is used as a reference category.6
Multinomial Logit ðPrfINVEFF ¼ 2; INVEFF ¼ 1gÞ ¼ f fOS; CONTROLSg Model ð1Þ
Measurements
Dependent Variable: Deviation from the Expected Level of Investment (INVEFF)
To determine our dependent variable (i.e., deviation from the expected, or normal level of investment) we, following
Biddle et al. (2009), first estimate a regression model Model (2) that regresses investment on growth opportunities (as measured
by sales growth). The model is described below:
INVESTtþ1 ¼ f fSALESGROWTHg Model ð2Þ
We the use the residuals from Model (2) as a firm-specific proxy for deviations from the expected investment (i.e., over-
and under-investment). Specifically, we regress total lead investment (INVESTtþ1) on sales growth (SALESGROWTH) within
each SIC two-digit industry-year combination from 2000 to 2009,7 and then quartile rank the residuals derived from Model (2).
Quartile 1 includes the most negative residuals representing under-investment (INVEFF ¼ 1), Quartile 4 includes the most
5
Biddle et al. (2009) employ two investment efficiency-based models to show firms with higher quality earnings invest more efficiently. First, they
adopt a conditional test using an Ordinary Least Squares regression model in which the dependent variable is total investment, and the independent
variables include financial reporting quality (FRQ), a categorical variable that indicates the likelihood of over-investment (OverI), and the interaction
between FRQ and OverI, along with other control variables. Second, they employ an unconditional test using a multinomial logistic regression model
to test the associations between residuals in the extreme quartiles of investments and financial reporting quality. Residuals surrogating the firm’s
deviation from the expected investment are deduced under a firm-specific model of investment as a function of investment opportunities. Subsequent
studies following their methodology have primarily employed either of the models. For example, Chen et al. (2011) have used a modified version of
their second model and Cheng et al. (2013) have used their first model. In this study we choose to employ the second model of Biddle et al. (2009)
primarily due to our research setting, which tests the likelihood of over- and under-investments in response to two groups of firms at the high and low
ends of our composite measure of OS scores, respectively. A multinomial logistic model allows us to more conveniently test the association of
prospector strategy with over-investment and the association of defender strategy with under-investment.
6
Employing Ordered Logit Regression as an alternative methodology in our additional analysis provides consistent results.

Business
71
7
Biddle et al. (2009) use the Fama and French (1997 ) 48-industry classification in their study, whereas Bentley et al. (2013) employ the SIC two-digit
industry classification. While we choose, for the sake of consistency, to employ the SIC two-digit classification in constructing our dependent variable
(investment efficiency) as well as our test variable (business strategy), we replicate our tests using the Fama and French (1997 ) 48-industry
classification and find that our results (untabulated) remain similar to those reported in the study.

Business
72
positive residuals representing over-investment (INVEFF ¼ 2), and Quartiles 2 and 3 include normal (expected) residuals
representing normal investment (INVEFF ¼ 0), which are used as a reference category.8 The multinomial logistic model, Model
(1), then predicts the likelihood that a firm will be in one of the extreme quartiles as opposed to the middle quartiles.9
Test Variable: Business Strategy

Prior studies (e.g., Bentley et al. 2013; Higgins et al. 2015) have employed an aggregate of six individual measures in
computing the firm’s business strategy score (OS). First, they use EMPS5 to show a firm’s ability to produce and distribute
products and services efficiently, measured as the ratio of employees to sales computed over a rolling prior five-year average.
For a given level of sales, prospectors use more employees compared to defenders, giving rise to a larger value of this ratio
representing lower operational efficiency. This is because prospectors focus more on diversifying their operations and exploring
new market opportunities thereby waiving the need for constant improvement in the standardization of their production
processes (Ittner and Larcker 1997; Rajagopalan 1997 ).
Second, they use a firm’s historical growth (REV5) to measure the one-year percentage change in total sales computed over
a rolling prior five-year average. Prior studies (Said, Hassab-Elnaby, and Wier 2003; Shortell and Zajac 1990) show that
prospectors tend to exhibit greater growth potential relative to defenders.
Third, a firm’s marketing and advertising effort (SGA5) is measured as the ratio of selling, general and administrative
expenditure to sales computed over a rolling prior five-year average. Prospectors rely more heavily on marketing and
advertising, in order to inform consumers about their new products that help distinguish them from competitors, relative to
defenders (Kotha and Nair 1995; Meyers-Levy 1989).
Fourth, a firm’s organizational stability (STDEMP5), measured as the standard deviation of total employees computed over
a rolling prior five-year period, is used to capture employee fluctuations. Miles and Snow (1978) and Thomas and Ramaswamy
(1996 ) suggest that employees in prospector firms tend to have shorter tenure as the movement of these professionals is project
driven. However, employee turnover in defender firms is lower, since employees who are trained and familiar with the
production process become fixated on their jobs, and their promotion depends on extensive internal knowledge and experience.
Bentley et al. (2013) and Higgins et al. (2015) have also used RDS5 that captures a firm’s propensity to explore new
products and markets (measured as the ratio of research and development expenditures to sales computed over a rolling prior
five-year average) and CAP5 that captures a firm’s capital intensity (measured as net property, plant and equipment scaled by
total assets computed over a rolling prior five-year period) to measure business strategy. Nevertheless, to avoid any potential
mechanical relationship between our dependent and test variables, we exclude both RDS5 and CAP5 in our measurement of OS
because these variables have been used in estimating the dependent variable (INVEFF).
Consequently we use four variables (EMPS5, REV5, SGA5, and STDEMP5) to compute OS. The four variables are quintile
ranked within each SIC two-digit industry and year, such that observations in the lowest (highest) quintile are given a score of 1
(5). We then sum the scores, for each firm-year, across the four variables to arrive at a composite OS score ranging from 4 to
20,10 with scores of 4–7 representing defenders, scores of 17–20 representing prospectors, and scores of 8–16 representing
analyzers. A higher (lower) of OS score thereby implies a firm’s tendency toward a prospector (defender) strategy.
Controls
Consistent with prior studies (e.g., Biddle et al. 2009; K. Chen, Z. Chen, and Wei 2011), we control for several firm
characteristics that serve as determinants of over- and under-investment. Moreover, we control for the level of investment by
including the ratio of investment to sales in all our models. Inclusion of this variable will isolate the effect of investment size
and ensure that our results are not driven by this variable. The definitions and measurements of all variables employed in our
analyses are detailed in Appendix B.
8
More recent studies also employ similar models to determine the levels of investment efficiency. For example, Chen et al. (2011) employ the residuals
from this model to investigate whether financial reporting quality contributes to investment efficiency. Cutillas Gomariz and Sánchez Ballesta (2014 )
use the residuals from this model to examine the impact of financial reporting quality and debt maturity on investment efficiency. Kim, Mauldin, and
Patro (2014 ) use the same approach to measure investment policy as a proxy for outside directors’ advising performance. Goodman, Neamtiu, Shroff,
and White (2014 ) employ a similar model to test the impact of management forecast quality on capital investment efficiency.
9
We replicate our analyses by correcting for both time-series and cross-sectional dependence in error terms following Gow, Ormazabal, and Taylor

Business
73
(2010) and Petersen (2009), and estimate our regression models using two-way clustering analysis by firm and year, within each SIC two-digit
industry-year combination, and our results (untabulated) remain consistent with those reported in our study.
10
We require each sample firm to have data on all four variables, hence giving a value of 4 (20) as a minimum (maximum).

Business
74
TABLE 1
Sample Selection and Distribution during 2000–2009
Panel A: Sample Selection
Observations
Initial sample with control variables available from 2000–2009 58,996
Less firm-years in the utilities and financial sectors (3,919)
Less firm-years with insufficient data to compute investment efficiency (4,432)
Less firm-years with insufficient data to compute rolling standard deviations for INVEST, CFO, REV, and AQUALITY (7,912)
Less firm-years with insufficient data to compute business strategy (6,726)
Final Sample 36,007
Panel B: Year Distribution of Sample Firms

Year Number of Firms Percent of Sample
2000 3,788 10.52
2001 3,664 10.18
2002 3,811 10.58
2003 3,827 10.63
2004 3,715 10.32
2005 3,575 9.93
2006 3,476 9.65
2007 3,438 9.55
2008 3,376 9.38
2009 3,337 9.27
Full Sample 36,007 100.00
Panel C: Industry Distribution of Sample Firms

Full Sample Prospectors Defenders
(36,007 ) (2,039 ) (1,974 )
Two-Digit
SIC Codes Industry Affiliation Number Percent Number Percent Number Percent
01–09 Agriculture, Forestry, and Fishing 83 0.23 7 0.34 5 0.25
10–14 Mining 2,105 5.85 142 6.96 89 4.51
15–17 Construction 281 0.78 17 0.83 27 1.37
20–39 Manufacturing 19,276 53.53 916 44.92 936 47.42
40–48 Transportation and Communications Services 2,064 5.73 193 9.47 162 8.21
50–51 Wholesale Trade 1,484 4.12 106 5.2 113 5.72
52–59 Retail Trade 2,641 7.33 151 7.41 165 8.36
70–89 Services 7,707 21.4 482 23.64 455 23.05
99 Other 366 1.02 25 1.23 22 1.11
Total 36,007 100.00 2,039 100.00 1,974 100.00
Data
We use data from Compustat, CRSP, I/B/E/S, and Execucomp to construct our dependent variable (normal, over-, and
under-investment), test variable (business strategy), and control variables. Data collection procedures and summary statistics on
the year and industry distributions of our sample firms are reported in Table 1.
We begin our sample selection procedure with 58,996 firm-year observations with available data for computing control
variables between 2000 and 2009 from Compustat. The sample is reduced by (1) 3,919 firm-years in the utilities and financial
sectors; (2) 4,432 firm-years with insufficient data to construct investment efficiency; (3) 7,912 firm-years with insufficient data

Business
75
to compute rolling standard deviations for INVEST, CFO, REV, and AQUALITY; and (4 ) 6,726 firm-years with insufficient data
to compute business strategy scores. This leads to a final sample of 36,007 firm-years in our study.

Business
76
Panel B of Table 1 reports the year distribution of our sample firms, which ranges from a minimum of 3,337 (9.27 percent)
in 2009 to a maximum of 3,827 (10.63 percent) in 2003. The distribution does not reveal any clustering. In Panel C, we report
the sample distribution by the two-digit standard industry codes (SIC ) for the entire sample as well as the subsamples of
prospectors and defenders. Consistent with Bentley et al. (2013), we find that the percentages of prospectors and defenders in
each industry are similar to the percentages of the full sample in each industry. This also supports Miles and Snow (1978) that
prospectors and defenders can co-exist in the same industry. For example, the largest industry represented in our sample is
manufacturing (SIC 20–39) with 19,276 firm-years (53.53 percent) in the entire sample, 916 (44.92 percent) in the subsample
of prospectors, and 936 (47.42 percent) in the subsample of defenders.
DESCRIPTIVE STATISTICS
In this section, we report untabulated descriptive statistics on investment residuals, business strategy, and control variables.
The mean (median) of the residuals capturing investment efficiency for the full sample (INVEFF) is 0.0012 ( 0.0341) with an
interquartile range between 0.0847 and 0.0285. There are 8,835 over-investment firm-years residing in Quartile 4 of the
residuals (INVEFF ¼ 2) with a mean (median) of 0.1932 (0.1133), whereas there are 9,182 under-investment firm-years
residing in Quartile 1 of the residuals (INVEFF ¼ 1) exhibiting a mean (median) of 0.1144 ( 0.1130). This is in line with
Biddle et al. (2009) that firm-years with the most positive (negative) residuals are classified as over- (under-) investing. There
are 17,990 normal investment firm-years residing in Quartiles 2 and 3 of the residuals (INVEFF ¼ 0), and this benchmark group
has a mean (median) of 0.0361 ( 0.0341) ranging from 0.0655 in Quartile 2 to 0.0081 in Quartile 3.11
The mean (median) of business strategy (OS) is 11.8828 (12.0000), and the scores range from 10 in Quartile 1 to 14 in
Quartile 3. The mean (median) of the 2,039 firm-year prospectors and 1,974 firm-year defenders are 17.5669 (17.0000) and
6.4169 (7.000), respectively. We also observe significant differences between the means of raw value for each individual OS
component across prospectors and defenders. The untabulated results from two-sample t-tests indicate that the means of
EMPS5, REV5, SGA5, and STDEMP5 are all significantly different across prospectors and defenders at the 1 percent level.
Further, we find that the mean INVEST_SALE for the full sample is 21.8045 and for prospectors (defenders) is 40.7819
(11.3058). The mean logarithm of total assets (SIZE ) for prospectors (defenders) is 5.2126 (4.4973), suggesting that on average
prospectors are larger than defenders. The growth rate (MB) of 2.8087 and 1.8655 for prospectors and defenders, respectively,
indicates that while stocks for both groups trade well above their book values, the growth rate of prospectors is noticeably
higher than that of defenders (Parnell and Wright 1993; Sabherwal and Chan 2001). Accruals quality (AQUALITY), defined
based on Dechow and Dichev (2002) and modified by McNichols (2002), is 0.0983 for prospectors, which is lower than that
of defenders ( 0.0814 ), suggesting prospectors have greater financial reporting irregularities (Bentley et al. 2013). The average
number of analysts (ANALYSTS) following prospectors (4.3276 ) is greater relative to defenders (1.7290). Approximately 33.13
percent of prospector firms have institutional shareholdings (INSTHLDG) compared to 27.05 percent for defenders, which is
consistent with existing studies that associate firms with greater visibility (for example, through advertising, growth, and
analyst coverage) with greater institutional holdings (e.g., Bhushan 1989; Grullon, Kantas, and Weston 2004; Bentley et al.
2014 ). The average firm age (FIRMAGE ) for prospectors (10.8848) is lower than that of defenders (18.4726 ). This is consistent
with prior research that suggests as product life cycle matures, defenders are more likely to survive in comparison to
prospectors (Covin 1991; Zammuto 1988; Zammuto and Cameron 1985).
We also compare the means of investment residuals representing over-investment (INVEFF ¼ 2) and under-investment
(INVEFF ¼ 1) across prospectors, analyzers, and defenders. Consistent with our expectations, we find that on average the over-
investment of prospectors (0.3280) is significantly—at the 1 percent level (t-statistic ¼ 8.40)—greater than the average over-
investment of defenders (0.1762). Prospectors also have greater over-investment than analyzers (0.3280 versus 0.1935). We
also find that on average the under-investment of defenders ( 0.1457 ) is significantly—at the 1 percent level (t-statistic ¼
4.81)—greater than the average under-investment of prospectors ( 0.1283). Defenders also have greater under-investment
relative to analyzers ( 0.1457 versus 0.1139). In sum, these statistics provide initial support for the over-investment of
prospectors and under-investment of defenders, while analyzers reasonably serve as the reference group.
In Table 2, we report a Pearson and Spearman correlation matrix. While we observe several significant correlations among
variables, the highest variance inflation factor (untabulated) is 3.07 for INDKSTRUC. This is less than the conservative
threshold of 5, above which multicollinearity could cause a threat to our results.

Business
77
11
We illustrate the validity of our modified business strategy scores and prospector-defender classification with real-life examples in Appendix A.

Business
78
TABLE 2
Pearson and Spearman Correlations
Panel A: Correlation Variables INVEFF to INDKSTRUC
(1) (2) (3) (4) (5) (6 ) (7) (8) (9) (10) (11)
1. INVEFF 0.0443 0.0679 0.1486 0.0338 0.0686 0.1055 0.0794 0.0276 0.0801 0.0023
2. OS 0.0549 0.1835 0.0760 0.0772 0.0310 0.0208 0.0767 0.0054 0.0056 0.0164
3. INVEST_SALE 0.1381 0.1578 0.0488 0.1941 0.0458 0.0493 0.1107 0.0196 0.1512 0.2014
4. SIZE 0.1540 0.0174 0.0962 0.1672 0.5108 0.4625 0.4573 0.2748 0.3295 0.2019
5. MB 0.0399 0.0413 0.0367 0.0476 0.2243 0.0653 0.2136 0.0725 0.2756 0.2161
6. INSTHLDG 0.0561 0.0378 0.0665 0.4953 0.0703 0.2740 0.2723 0.0186 0.0396 0.0324
7. AQUALITY 0.1162 0.0751 0.1051 0.4599 0.0223 0.2788 0.3122 0.2491 0.1630 0.1372
8. CFO 0.1085 0.1637 0.5738 0.3162 0.0047 0.1815 0.2844 0.2387 0.0482 0.0883
9. TANGIBIL 0.007 0.0136 0.0858 0.2227 0.0511 0.0142 0.1797 0.1217 0.3896 0.4442
10. KSTRUC 0.0879 0.0136 0.0657 0.2055 0.1701 0.0120 0.1027 0.0804 0.3202 0.4017
11. INDKSTRUC 0.0033 0.0158 0.0741 0.1912 0.0886 0.0298 0.1224 0.0897 0.4486 0.4296
12. SLACK 0.0381 0.0264 0.1178 0.1965 0.0630 0.0573 0.1491 0.1625 0.3480 0.2203 0.1960
13. DIVDUM 0.0769 0.1020 0.1188 0.4931 0.0281 0.1252 0.2062 0.1428 0.1729 0.0420 0.1508
14. ZSCORE 0.0634 0.2093 0.3810 0.2234 0.0516 0.2218 0.2089 0.3064 0.0351 0.0969 0.0359
15. FIRMAGE 0.0913 0.1452 0.1401 0.3403 0.0126 0.2086 0.1556 0.1033 0.0687 0.0790 0.0686
16. ANALYSTS 0.0435 0.0914 0.0036 0.4169 0.1211 0.5322 0.2079 0.1513 0.0398 0.0843 0.0461
17. STD_INVEST 0.0625 0.3392 0.1953 0.1209 0.0078 0.0716 0.1605 0.1461 0.0002 0.0471 0.0200
18. STD_CFO 0.1348 0.1751 0.1690 0.4956 0.0179 0.2700 0.5649 0.3009 0.2035 0.1754 0.1668
19. STD_REV 0.0720 0.0531 0.0410 0.3611 0.0165 0.1895 0.4363 0.0950 0.2058 0.0944 0.1012
20. OPCYCLE 0.0244 0.0232 0.0839 0.0523 0.0156 0.0016 0.0157 0.0893 0.2928 0.1388 0.2539
21. LOSS 0.0553 0.1231 0.2072 0.4351 0.0786 0.2571 0.2302 0.3000 0.0675 0.1158 0.0323
Panel B: Correlation Variables SLACK to LOSS

(12) (13) (14 ) (15) (16 ) (17) (18) (19) (20) (21)
1. INVEFF 0.0471 0.0756 0.0612 0.0749 0.0634 0.0821 0.1350 0.0773 0.0294 0.0616
2. OS 0.0495 0.0901 0.1970 0.1943 0.1000 0.3566 0.0798 0.0339 0.0159 0.1071
3. INVEST_SALE 0.1837 0.1098 0.4942 0.1748 0.1351 0.3187 0.1009 0.1371 0.1369 0.1288
4. SIZE 0.2543 0.4190 0.2091 0.2249 0.5505 0.1034 0.5755 0.3944 0.0591 0.3552
5. MB 0.1852 0.1051 0.1469 0.000 0.2981 0.0192 0.0246 0.0450 0.0387 0.2448
6. INSTHLDG 0.0083 0.1240 0.2332 0.1794 0.6470 0.0354 0.2940 0.1730 0.0017 0.2556
7. AQUALITY 0.2015 0.2512 0.1304 0.1491 0.2845 0.1230 0.5375 0.4290 0.0395 0.2201
8. CFO 0.1233 0.2526 0.2570 0.1043 0.3368 0.0361 0.3354 0.2884 0.0953 0.5168
9. TANGIBIL 0.7507 0.2263 0.0665 0.1232 0.0394 0.0039 0.2948 0.2605 0.1988 0.1037
10. KSTRUC 0.5458 0.1349 0.0346 0.1345 0.0074 0.0276 0.2996 0.1610 0.1054 0.0073
11. INDKSTRUC 0.4669 0.1803 0.0854 0.0771 0.0380 0.0572 0.2231 0.1435 0.2115 0.0515
12. SLACK 0.2349 0.1426 0.1707 0.0204 0.0223 0.3335 0.2115 0.0977 0.1185
13. DIVDUM 0.1538 0.2458 0.3345 0.1720 0.2140 0.3686 0.2610 0.0228 0.2955
14. ZSCORE 0.1579 0.2458 0.2391 0.1895 0.3218 0.2260 0.0352 0.0603 0.6013
15. FIRMAGE 0.1334 0.3507 0.2292 0.1125 0.3119 0.2804 0.1736 0.0905 0.1967
16. ANALYSTS 0.0327 0.2083 0.1311 0.2989 0.006 0.2734 0.1857 0.0012 0.2782
17. STD_INVEST 0.0660 0.1683 0.2784 0.2325 0.0428 0.2513 0.2059 0.0898 0.1813
18. STD_CFO 0.2228 0.2677 0.2674 0.2295 0.1868 0.3123 0.5111 0.0275 0.3005
19. STD_REV 0.1312 0.2072 0.0260 0.1712 0.1459 0.2222 0.4788 0.0848 0.1610
20. OPCYCLE 0.0071 0.0006 0.0526 0.0156 0.0093 0.1009 0.0287 0.1134 0.0118
21. LOSS 0.0988 0.4064 0.6013 0.2003 0.1980 0.1818 0.2720 0.1583 0.0195
This table presents Pearson (Spearman) correlations for the variables employed in main regression analyses at the lower (upper) diagonal. Correlations
significant at the 0.05 or lower levels are in bold. See Appendix B for variable definitions.

Business
79
EMPIRICAL RESULTS
Information Asymmetry and Future Performance

So far in our discussions we have relied on prior research to argue that prospector strategy has higher information
asymmetry, and the over-/under-investment should lead to deteriorated future performance. In this section, we empirically test
the information asymmetry and future firm performance assertions.
Following Chang, Chen, Liao, and Mishra (2006 ), we employ an OLS model where the dependent variable SPREAD
(firm-level bid-ask spread as a proxy for information asymmetry) is regressed on OS and control variables. Because of the
missing data on SPREAD, VOLUME, and RETURN, the sample is reduced to 29,054 observations. Our untabulated results
indicate that the coefficient of OS is 0.0002, which suggests that the increase in OS is positively and significantly (at the 1
percent level) associated with the increase in SPREAD, with an adjusted R2 of 35.79 percent. This evidence supports the notion
that prospectors have higher information asymmetry, which can drive inefficient investments.
Moreover, to show that over- and under-investment adversely affect firms’ subsequent performance, we regress three
measures of average firm-level return on assets (ROA) representing firm-level performance in time tþ1, tþ2, and tþ3 on the
absolute value of investment residuals (ABS_INVEST). We expect the coefficient on ABS_INVEST to be negative, suggesting
that larger absolute investment residuals lead to poorer future firm performance. For the purpose of this analysis, we follow
Jung, Lee, and Weber (2014 ), who regress average firm-year ROA across the subsequent three years on an inefficient
investment in labor in their study. Because of the missing data required to estimate the three-year average ROA and control
variables, our sample is reduced to 33,113, 30,651, and 28,423 observations in time tþ1, tþ2, and tþ3, respectively. Our results
(untabulated) show that the coefficient on ABS_INVEST is 0.0046, 0.0037, and 0.0037 in time tþ1, tþ2, and tþ3,
respectively, which are significant at the 1 percent level. These results support our argument of poor performance due to over-
(under-) investment.
Multinomial Logistic Model

Turning to our main analysis, the results reported in Table 3 are from our baseline multinomial logistic regression Model
(1), which tests H1 and H3; namely, the likelihood of over-investment as a function of prospector strategy and the likelihood of
under-investment as a function of defender strategy.
The results from the tests of over- (under-) investment of prospectors (defenders) are reported under the heading INVEFF ¼
2 (INVEFF ¼ 1) in Table 3. The results for INVEFF ¼ 2 indicate a positive (0.0346 ) and significant (at the 1 percent level)
coefficient for OS, suggesting that prospector strategy is associated with the likelihood of over-investment. On the other hand,
the results for INVEFF ¼ 1 show a negative coefficient for OS ( 0.0456 ), which is also significant at the 1 percent level,
suggesting that defender strategy is associated with the likelihood of under-investment. The Pseudo R2 and the results for
control variables are similar to those reported in Biddle et al. (2009).
The results from tests of H2 and H4 are reported in Table 4. While our main results reported in Table 3 suggest that over-
(under-) investment is more likely to be associated with prospector (defender) strategy, the results in Table 4 are expected to
show whether the likelihood of over- (under-) investment associated with prospectors (defenders) is more pronounced when
managers have higher stock- (cash-) based compensation. We capture stock- and option-based compensation with
STOCKRATIO, which is the ratio of the CEO stock and option compensation to total CEO compensation, and cash-based
compensation with CASHRATIO, which is the ratio of CEO cash compensation to total CEO compensation. Our test variables
are the interactive terms STOCKRATIO OS and CASHRATIO OS. The lack of compensation data reduces our sample to
22,149 firm-years for these tests. The median CASHRATIO for the full sample is 0.1030, and the defender subsample (0.1146 )
has a higher median than the prospector subsample (0.0953). The median for STOCKRATIO is 0.2628, and the prospector
subsample (0.3770) displays a higher median than the defender subsample (0.1940). These statistics provide preliminary
insights supporting our arguments that prospectors (defenders) tend to adopt stock- and option- (cash-) based compensation.
For INVEFF ¼ 2, Panel A of Table 4 shows a positive coefficient (0.0164 ) on STOCKRATIO OS that is significant at the
5 percent level, whereas the coefficient ( 0.0324 ) on CASHRATIO OS is insignificant. This result indicates that the likelihood
of over-investment associated with the prospector business strategy is more pronounced when there is a greater level of stock-
and option-based compensation, however cash-based compensation, as expected, does not influence such a relationship.
Conversely, for INVEFF ¼ 1, Panel A of Table 4 shows an insignificant coefficient (0.0080) on STOCKRATIO OS, yet a
negative coefficient ( 0.1454 ) on CASHRATIO OS that is significant at the 5 percent level. This evidence indicates that the
likelihood of under-investment associated with the defender business strategy is more pronounced when there is a greater level
of cash-based compensation, however stock- and option-based compensation does not influence, as expected, such a

Business
80
relationship. To address the concern that STOCKRATIO and CASHRATIO are negatively correlated and should be tested
separately in the compensation model, we run the two interactions separately. Consistently, Panel B reflects that the coefficient

Business
81
TABLE 3
The Multinomial Logistic Regression of the Likelihood of Over-Investment (INVEFF ¼ 2) and Under-Investment
(INVEFF ¼ 1) on Business Strategy (OS) and Control Variables, Using Normal Investment (INVEFF ¼ 0) as a
Reference Category
INVEFF ¼ 2 INVEFF ¼ 1
2
Variable Estimate Std. Error Pr . v Estimate Std. Error Pr . v2
Intercept 0.0703 (0.4041) 0.8620 1.0946 (0.3794 ) 0.0039

OS 0.0346 (0.0069) , 0.0001 0.0456 (0.0075) , 0.0001
INVEST_SALE 0.0087 (0.0006 ) , 0.0001 0.0116 (0.0016 ) , 0.0001
SIZE 0.1727 (0.0150) , 0.0001 0.0755 (0.0139) , 0.0001
MB 0.0191 (0.0034 ) , 0.0001 0.0117 (0.0036 ) 0.0012
INSTHLDG 0.3310 (0.0716 ) , 0.0001 0.2430 (0.0771) 0.0016
AQUALITY 1.1889 (0.2657 ) , 0.0001 1.1802 (0.2594 ) , 0.0001
CFO 0.1750 (0.0331) , 0.0001 0.2413 (0.0398) , 0.0001
TANGIBIL 0.7416 (0.1258) , 0.0001 1.3419 (0.1526 ) , 0.0001
KSTRUC 1.6657 (0.1107 ) , 0.0001 1.1106 (0.0942) , 0.0001
INDKSTRUC 1.6922 (0.4855) 0.0005 1.2559 (0.4767 ) 0.0084
SLACK 0.0031 (0.0020) 0.1210 0.0053 (0.0026 ) 0.0420
DIVDUM 0.0251 (0.0463) 0.5877 0.1390 (0.0482) 0.0039
ZSCORE 0.2521 (0.0965) 0.0090 0.0544 (0.1077 ) 0.6135
FIRMAGE 0.0100 (0.0017 ) , 0.0001 0.0040 (0.0018) 0.0267
ANALYSTS 0.0133 (0.0029) , 0.0001 0.0218 (0.0041) , 0.0001
STD_INVEST 0.0008 (0.0008) 0.3198 0.0014 (0.0010) 0.1421
STD_CFO 0.8529 (0.2240) 0.0001 0.3231 (0.2461) 0.1892
STD_REV 0.0726 (0.0810) 0.3703 0.3143 (0.0820) 0.0001
OPCYCLE 0.1289 (0.0264 ) , 0.0001 0.0518 (0.0323) 0.1089
LOSS 0.2319 (0.0443) , 0.0001 0.1788 (0.0451) 0.0001
Industry Effect Included Included
Year Effect Included Included
n 36,007
Pseudo R2 0.0786
This table presents the results from multinomial logistic regression analyses of the likelihood of over-investment (INVEFF ¼ 2) and under-investment
(INVEFF ¼ 1) on business strategy (OS) and control variables. See Appendix B for variable definitions.
on STOCKRATIO OS is positive (0.0182) and significant at the 5 percent level for over-investment (i.e., INVEFF ¼ 2), yet
positive (0.0100) and insignificant for under-investment (i.e., INVEFF ¼ 1). Conversely, Panel C shows that while the
coefficient on CASHRATIO OS is negative ( 0.1369) and significant at the 5 percent level for under-investment (i.e.,
INVEFF ¼ 1), it is negative ( 0.0233) and insignificant for over-investment (i.e., INVEFF ¼ 2). Collectively, these results
support H2 and H4.
Analyses of Prospectors versus Defenders

Our multivariate analyses in Table 3 included regressions of the likelihood of INVEFF ¼ 2 and INVEFF ¼ 1 on OS. In this
section, we employ a more robust examination by excluding analyzers and restricting our test variable to only prospectors and
defenders, and our dependent variable to only over-investment and under-investment (i.e., excluding normal investment). In
this binary logistic model, we employ two versions of OS. In the first version, we code OS as 1 for prospectors and 0 for
defenders so that we can measure the incremental effect of our test variable on over- and under-investment. In the second
version, we simply use OS as a continuous variable to measure the effect of higher and lower OS scores within each strategy on
over- and under-investment. The untabulated results based on OS as a categorical variable indicate that the coefficient of OS is

Business
82
positive and significant at the 1 percent level, indicating that the likelihood of over-investment is significantly higher for
prospectors than for defenders.
Our next test intends to show the evidence of (1) the greater likelihood of over-investment for prospector firms with OS
scores closer to the upper end, relative to those approaching the lower end, and (2) the greater likelihood of under-investment

Business
83
TABLE 4
The Multinomial Logistic Regression of the Likelihood of Over-Investment (INVEFF ¼ 2) and Under-Investment
(INVEFF ¼ 1) on Business Strategy (OS), CEO Stock-Based Compensation Ratio (STOCKRATIO),
CEO Cash-Based Compensation Ratio (CASHRATIO), Interactions of OS with These CEO Compensation Structures
(OS STOCKRATIO and OS CASHRATIO), and Control Variables,
Using Normal Investment (INVEFF ¼ 0) as a Reference Category
Panel A: Interacting STOCKRATIO and CASHRATIO with OS
2
Intercept 0.5022 (0.4501) 0.2646 0.8962 (0.5289) 0.0902

OS 0.0359 (0.0122) 0.0031 0.0444 (0.0131) 0.0007
STOCKRATIO 0.1820 (0.0889) 0.0405 0.1087 (0.1246 ) 0.3829
STOCKRATIO OS 0.0164 (0.0076 ) 0.0308 0.0080 (0.0113) 0.4764
CASHRATIO 0.5290 (0.7779) 0.4964 1.9749 (0.7944 ) 0.0129
CASHRATIO OS 0.0324 (0.0638) 0.6112 0.1454 (0.0643) 0.0238
Controls Included Included
n 22,149
Pseudo R2 0.0773
Panel B: Interacting Only STOCKRATIO with OS

2
Intercept 0.6477 (0.4529) 0.1527 1.2983 (0.4998) 0.0094

OS 0.0237 (0.0102) 0.0201 0.0675 (0.0109) 0.001
STOCKRATIO 0.2283 (0.0991) 0.0212 0.1173 (0.0992) 0.2372
STOCKRATIO OS 0.0182 (0.0080) 0.0234 0.0100 (0.0086 ) 0.2423
n 22,149
Pseudo R2 0.0771
Panel C: Interacting Only CASHRATIO with OS

2
Intercept 0.8045 (0.4584 ) 0.0792 1.0473 (0.5071) 0.0389

OS 0.0353 (0.0114 ) 0.0020 0.0472 (0.0121) 0.0001
CASHRATIO 0.4352 (0.7187 ) 0.5449 1.7800 (0.7409) 0.0162
CASHRATIO OS 0.0233 (0.0590) 0.6927 0.1369 (0.0608) 0.0243
n 22,149
Pseudo R2 0.0772
This table presents the results from multinomial logistic regression analyses of the likelihood of over-investment (INVEFF ¼ 2) and under-investment
(INVEFF ¼ 1) on business strategy (OS) and its simultaneous interactions with STOCKRATIO and CASHRATIO (Panel A), its interaction with only
STOCKRATIO (Panel B), and its interaction with only CASHRATIO (Panel C) controlling for other investment determinants. See Appendix B for variable
definitions.

Business
84
for defender firms with OS scores closer to the lower end, relative to those approaching the upper end. The results (untabulated)
from these analyses indicate a positive (negative) coefficient for prospector (defender) strategy, which is significant at the 1
percent level, suggesting that within the subsample of prospector (defender) firms, the likelihood of over- (under-) investment is
greater for prospectors (defenders) at the upper (lower) end their relevant OS score, providing more robust support for our main
results.
ADDITIONAL ANALYSES
Controlling for Other Determinants of Sub-Optimal Investment Decisions

One potential caveat to our main results could be that we have only relied on agency conflicts to motivate the over- and
under-investment of prospector and defender managers, respectively. Bertrand and Schoar (2003) suggest that managerial
attributes affect corporate investment decisions, and several studies (e.g., Heaton 2002; Stein 2003; Roll 1986 ) acknowledge
that there are factors other than agency conflicts giving rise to over-investment, such as managerial overconfidence.
Specifically, overconfident managers are likely to be overoptimistic about the prospects of assets under their control. We,
therefore, employ two measures of overconfidence (OVERCONFIDENCE ) based on Malmendier and Tate (2005, 2008). We
collect data on CEO stock option holdings and stock ownership from Execucomp, and for the first proxy we require the CEO to
have exercisable in-the-money options. Each observation also needs to have at least two years of compensation data to examine
the option-exercising behavior. A CEO is deemed ‘‘overconfident’’ if he/she failed to exercise his/her vested options when the
options were more than 67 percent in-the-money at least twice during the sample period. The second measure classifies a CEO
as overconfident (for all of his/her years in the sample) if he/she ever holds an option until its expiration.12
Investment efficiency could also be influenced by material internal control weaknesses (Cheng et al. 2013). Thus, we also
control for internal control weaknesses (ICMW) by coding this variable a value of 1 if the sample firm has an internal control
weakness attributed to Sarbanes-Oxley Act Sections 302 or 404 from Audit Analytics, and 0 otherwise. Finally, managerial
errors of judgment in investment decisions can lead to higher overall risk in the long run. Accordingly, we also control for firm
overall risk (STD_RET), which is measured as the standard deviation of daily stock returns over a fiscal year.
We lose more than half of our sample firm-years after controlling for OVERCONFIDENCE, ICMW, and STD_RET. Based
on 13,366 firm-years, the results (untabulated) for this additional analysis suggest that OS remains (1) positively (0.0371) and
significantly—at the 1 percent level—associated with the likelihood of over-investment (INVEFF ¼ 2), and (2) negatively (
0.0647 ) and significantly—at the 1 percent level—associated with the likelihood of under-investment (INVEFF ¼ 1),
suggesting that our main results are robust in the presence of OVERCONFIDENCE, ICMW, and STD_RET.
Ordered Logit Regression

In this section we repeat our main analysis using an ordered logit regression to test the robustness of our results. We first
quartile rank positive (over-investment) and negative (under-investment) residuals in each SIC two-digit industry and year
combination and then regress them separately on OS and control variables,13 and report the results in Table 5.
The results suggest that the coefficient on OS for the over-investment subsample is positive (0.0158) and significant at the
5 percent level, and similarly the results for the under-investment subsample indicate that the coefficient of OS is negative (
0.0302) and significant at the 1 percent level. These additional results collectively support our main results reported in the
paper.
Analyses of OS Components
In this analysis, we replace OS by each of its four components to ensure the results we have observed so far are not driven
by any particular component of OS. One of the caveats in this approach is that the individual variables may not properly
represent prospector or defender strategies since business strategy is defined by a collection of attributes instead of an isolated
attribute. The untabulated results from these analyses indicate that two individual characteristics of innovation/marketing and
growth pointing toward prospector strategy, namely SGA5 and STDEMP5, are positively (0.1216 and 0.0533) and significantly
(at the 1 percent level) associated with the likelihood of over-investment, and negatively ( 0.2274 and 0.0565) and
significantly (at the 1 percent significance level) associated with the likelihood of under-investment. The third component,

Business
85
12
Malmendier and Tate (2005, 2008) use a third measure, NETBUYER, which classifies a CEO as overconfident when over a set period a CEO buys more
stock than he sells in the company. However, because this measure was constructed in their study based on proprietary data, we were unable to
construct it.
13
Our results remain statistically the same when we use a decile-rank approach.

Business
86
TABLE 5
Quartile-Ranked Ordered Logistic Regression of Positive and Negative Investment
Residuals on Business Strategy (OS) and Control Variables
Quartile-Ranked Over-Investments Quartile-Ranked Under-Investments
2
OS 0.0158 (0.0076 ) 0.0362 0.0302 (0.0065) , 0.0001

INVEST_SALE 0.0062 (0.0006 ) , 0.0001 0.0066 (0.0007) , 0.0001
SIZE 0.1846 (0.0144 ) , 0.0001 0.0550 (0.0125) , 0.0001
MB 0.0086 (0.0034 ) 0.0119 0.0195 (0.0036 ) , 0.0001
INSTHLDG 0.3034 (0.0702) , 0.0001 0.1822 (0.0655) 0.0054
AQUALITY 1.7972 (0.2957 ) , 0.0001 1.7765 (0.2538) , 0.0001
CFO 0.0811 (0.0363) 0.0254 0.1745 (0.0353) , 0.0001
TANGIBIL 0.0649 (0.1438) 0.6516 1.0763 (0.1201) , 0.0001
KSTRUC 0.5773 (0.1255) , 0.0001 1.1047 (0.0774) , 0.0001
INDKSTRUC 1.8763 (0.5785) 0.0012 5.7911 (0.4275) , 0.0001
SLACK 0.0043 (0.0025) 0.0848 0.0048 (0.0023) 0.0344
DIVDUM 0.0116 (0.0503) 0.8181 0.1605 (0.0395) , 0.0001
ZSCORE 0.2302 (0.1180) 0.0510 0.0664 (0.0883) 0.4519
FIRMAGE 0.0040 (0.0018) 0.0286 0.0048 (0.0014) 0.0007
ANALYSTS 0.0027 (0.0028) 0.3335 0.0202 (0.0031) , 0.0001
STD_INVEST 0.0004 (0.0010) 0.6538 0.0000 (0.0009) 0.9573
STD_CFO 0.4218 (0.2563) 0.0998 0.7381 (0.2388) 0.0020
STD_REV 0.0408 (0.1010) 0.6858 0.3018 (0.0771) 0.0001
OPCYCLE 0.1736 (0.0312) , 0.0001 0.0967 (0.0276 ) 0.0005
LOSS 0.3308 (0.0565) , 0.0001 0.1336 (0.0372) 0.0003
Year Effect Included Included
n 12,238 23,769
Pseudo R2 0.0671 0.1169
This table presents the results from ordered logistic regression analyses of the likelihood of over-investment (quartile rank of positive investment residuals)
and under-investment (quartile rank of the absolute value of negative investment residuals) on business strategy (OS) and control variables. See Appendix
B for variable definitions.
REV5, is not significantly associated with the likelihood of under-investment; however, it is positively (0.0363), at the 1 percent
significance level, associated with the likelihood of over-investment. As for the remaining component EMPS5, it is not
significantly associated with the likelihood of under-investment or over-investment. Collectively, two out of four components
of OS produce confirming results for both the likelihood of over- and under-investment (SGA5, STDEMP5), and among the
remaining two variables one confirms the likelihood of over-investment (REV5).
Analysis of Investment Components

To ensure our results are not affected by any particular component of investment, we, similar to Biddle et al. (2009),
decompose total investment into two components; namely, capital expenditure scaled by lagged PPE (CAPEX), and noncapital
expenditure including acquisitions and R&D scaled by lagged total assets (NCAPEX) as alternative dependent variables to
derive residuals in Model (2). We then replicate our multinomial logistic analyses using the investment components as our
dependent variables. The results (untabulated) suggest that the coefficients on OS under INVEFF ¼ 2 are positive (0.0819 and
0.0207, respectively) with a 1 percent level of significance, when dependent variables are based on residuals estimated from
regressions of CAPEX and NCAPEX on investment opportunities. This reinforces the findings that prospectors are more likely
to over-invest. Under INVEFF ¼ 1, the coefficient on OS is negative ( 0.0478) with a 1 percent level of significance using
residuals from the model of CAPEX as our dependent variable. However, the coefficient on OS is not statistically significant

Business
87
when residuals from the model of NCAPEX are employed as the dependent variable. This suggests that CAPEX mainly
accounts for the likelihood of under-investment associated with the defender strategy.

Business
88
Year-by-Year and Industry-by-Industry Analyses

We further replicate our main multinomial logistic analyses for each year and each industry to allow the parameter estimate
on OS to vary across years and industries. The untabulated results from the year-by-year (industry-by-industry) regression
analyses indicate that the mean coefficients of OS are 0.0336 (0.0461) for INVEFF ¼ 2 and 0.0475 ( 0.0682) for INVEFF ¼
1, respectively. Our t-statistics computed using the time-series variability in the coefficient estimates as in Fama and MacBeth
(1973), are 4.24 (2.65) for INVEFF ¼ 2 and 6.33 ( 3.87 ) for INVEFF ¼ 1, respectively. These results confirm that our main
findings are not influenced by industries and years with higher representations in the sample.
ROBUSTNESS CHECKS
Our analyses so far are based on the notion that business strategy affects investment efficiency, and compensation type
influences such a relationship. We are unaware of studies that suggest an opposite relation. Moreover, and consistent with
Rajan and Zingales (1998), we consider two interaction effects (through compensation) discussed earlier that make it difficult to
argue for reverse causality. Nevertheless, as an additional analysis we control for lagged investment residuals (i.e., a lagged
dependent variable) to further rule out reverse causality (Klein 1998). There are also possibilities where our results are subject
to other forms of endogeneity, such as correlated omitted variables or confounding factors, which we examine below with first-
differenced specifications, firm fixed-effects, and propensity score matching (Chen et al. 2011; Gallemore and Labro 2015;
Prawitt, Sharp, and Wood 2012).
Controlling for Lagged Investment Residuals

Klein (1998) and Chen et al. (2011) suggest that controlling for a lagged dependent variable helps mitigate the concern of
reverse causality. Thus, we include lagged investment residuals as a control variable and re-estimate our model. Untabulated
results show that the coefficients on OS are positive (0.0317 ) for INVEFF ¼ 2 and negative ( 0.0074 ) for INVEFF ¼ 1,
respectively. Both coefficients are significant at the 1 percent level. This allows us to establish the causation where the
prospector (defender) business strategy leads to over- (under-) investment.
First-Differenced Specification
Following Gallemore and Labro (2015) we employ a first-differenced specification to mitigate the effect of unobservable
firm-specific characteristics that are relatively constant over time. We identify actual changes in OS and we then regress the
corresponding changes in firm-level investment residuals on changes in OS and control variables.14 We exclude from this
analysis the firm-year observations where the OS score does not change during the year. We report the results in Table 6. Panel
A reports the analysis results for the full sample of positive and negative investment residuals. The coefficient on DOS is
positive (0.3129) and significant at the 1 percent level, suggesting that actual changes in the OS scores are associated with
changes in investment residuals. Panel B focuses on the positive investment residuals only and the results show that, consistent
with our main results, the coefficient on DOS is positive (0.5225) and significant at the 5 percent level. Panel C focuses on the
negative investment residuals only and the results show that, consistent with our main results, the coefficient on DOS is
negative ( 0.1196 ) and significant at the 1 percent level, further confirming our main results.
Controlling for Firm Fixed-Effects

The firm fixed-effects specification also helps eliminate time-invariant unobservable characteristics that may affect
investment efficiency (Chen et al. 2011). We apply this test to check the robustness of our results for the compensation
hypotheses. Untabulated results continue to show a positive coefficient (0.0910) on STOCKRATIO OS that is significant at
the 5 percent level, whereas the coefficient (0.0527 ) on CASHRATIO OS is, as expected, insignificant, when INVEFF ¼ 2
14
Miles and Snow (1978) assert that business strategy rarely changes and therefore it is possible that in our sample we do not observe changes between
defenders and prospectors, especially since we use strict measures of defenders (i.e., scores of 4 to 7) and prospectors (scores of 17 to 20). We,
therefore, examine real changes in strategies during our sample period and our results (untabulated) show that no defender ( prospector) firm changed its
strategy to prospector (defender). However, changes took place within the scores of prospector strategy, defender strategy, and analyzer strategy.
Furthermore, changes also took place from the prospector to analyzer and from the analyzer to prospector strategy and from the defender to analyzer
strategy and vice versa. On the whole, we found that 343 prospector firms changed their strategy within the scores of 17 to 20, 451 defender firms
changed their strategy within the scores of 4 to 7, and 13,741 analyzer firms changed their strategy within the scores of 8 to 16. We also found that 448

Business
89
(322) firms changed their prospector (analyzer) strategy to analyzer ( prospector) strategy and, finally, 441 (442) firms changed their defender (analyzer)
strategy to analyzer (defender) strategy, suggesting that our change-in-changes regression analyses reported earlier in the paper comprise only the above
changes since there have been no changes between the defender and prospector strategies.

Business
90
TABLE 6
First-Differenced Regression Analysis of the Change across All Investment Residuals (Panel A),
Positive Residuals (Panel B), and Negative Residuals (Panel C ), Separately on Real Changes in Business Strategy
(DOS) and Changes in Control Variables
Panel A: Change in Panel B: Change in Panel C: Change in
Investment Residuals Positive Investment Residuals Negative Investment Residuals
Variable Estimate Std. Error Pr . v2 Estimate Std. Error Pr . v2 Estimate Std. Error Pr . v2
Intercept 0.2099 (2.5777 ) 0.9350 1.0398 (5.8284) 0.8580 0.0386 (1.1301) 0.9730
DOS 0.3129 (0.0931) 0.0010 0.5225 (0.2432) 0.0320 0.1196 (0.0357 ) 0.0010
DINVEST_SALE 0.1172 (0.0045) , 0.0001 0.0940 (0.0104) , 0.0001 0.0072 (0.0022) 0.0010
DSIZE 18.8365 (0.4294 ) , 0.0001 22.7996 (1.0488) , 0.0001 3.0791 (0.1999) , 0.0001
DMB 0.0424 (0.0236 ) 0.0720 0.0565 (0.0476 ) 0.2350 0.0164 (0.0104 ) 0.1130
DINSTHLDG 9.6997 (1.5652) , 0.0001 12.6742 (3.6810) 0.0010 1.1301 (0.6206 ) 0.0690
DAQUALITY 1.7867 (3.2786 ) 0.5860 0.1242 (7.6930) 0.9870 1.8857 (1.2592) 0.1340
DCFO 3.2720 (0.2955) , 0.0001 3.6661 (0.6591) , 0.0001 0.4143 (0.1249) 0.0010
DTANGIBIL 9.9646 (2.2653) , 0.0001 9.4149 (5.7733) 0.1030 6.7954 (0.9456 ) , 0.0001
DKSTRUC 12.6911 (0.9952) , 0.0001 17.9166 (3.1836 ) , 0.0001 1.4975 (0.3487 ) , 0.0001
DINDKSTRUC 21.4071 (4.9341) , 0.0001 21.6835 (13.0689) 0.0970 19.9593 (1.9041) , 0.0001
DSLACK 0.2628 (0.0225) , 0.0001 0.1183 (0.0510) 0.0200 0.0245 (0.0100) 0.0140
DDIVDUM 0.1368 (0.5549) 0.8050 3.1500 (1.5881) 0.0470 0.1683 (0.2043) 0.4100
DZSCORE 10.8322 (0.9772) , 0.0001 9.2979 (2.6485) , 0.0001 0.2938 (0.3777 ) 0.4370
DANALYSTS 0.1918 (0.0537 ) , 0.0001 0.3202 (0.1208) 0.0080 0.0037 (0.0222) 0.8670
DSTD_INVEST 0.0612 (0.0117 ) , 0.0001 0.0436 (0.0288) 0.1290 0.0031 (0.0045) 0.4980
DSTD_CFO 4.3163 (3.0742) 0.1600 2.6722 (6.5381) 0.6830 0.0890 (1.3085) 0.9460
DSTD_REV 0.8077 (1.0931) 0.4600 1.6169 (3.0403) 0.5950 0.1974 (0.4093) 0.6300
DOPCYCLE 1.1945 (0.3109) , 0.0001 0.4319 (0.6397) 0.5000 0.4169 (0.1294 ) 0.0010
DLOSS 0.5322 (0.3313) 0.1080 0.3131 (0.9623) 0.7450 0.2864 (0.1204 ) 0.0170
Industry Effect Included Included Included
Year Effect Included Included Included
n 16,188 3,287 8,482
Adj. R2 0.2002 0.1972 0.1189
This table presents the results for a first-differenced specification for the full sample (Panel A), and in the subsamples of positive change (Panel B) and
negative change (Panel C ) of investment residuals, respectively. See Appendix B for variable definitions.
(over-investment). Conversely, the coefficient ( 0.070) on STOCKRATIO OS is, as expected, insignificant, but the coefficient (
0.1655) on CASHRATIO OS is significant at the 5 percent level, when INVEFF ¼ 1 (under-investment). Thus, the
likelihood of over-investment (under-investment) associated with the prospector (defender) business strategy is more
pronounced when there is a greater level of stock- and option- (cash-) based compensation.
Propensity Score Matching

We further mitigate the correlated omitted variable issue for the compensation hypotheses with a propensity score
matching procedure. Similar to Prawitt et al. (2012) and Cheng et al. (2013), we create a sample of firms with a set of similar
characteristics that affect investment residuals but differ by business strategy and CEO compensation. This allows us to
minimize the variation in observable confounding variables driving investment residuals while maximizing the variation in
business strategy and CEO compensation, so that differences in investment residuals can be attributed to the difference between
compensation types under prospector- versus defender-like business strategies.
Because the number of prospectors and defenders for the CEO compensation sample is only 448 and 379, respectively, and
the matching technique further reduces the number of observations, we increase the matched sample size by creating larger

Business
91
prospector- and defender-like groups. Specifically, we create an indicator variable, OSDMY, where all companies with an OS
score between 13 and 20 are identified as prospector-like and all companies with an OS score between 4 and 12 are identified as
defender-like. We first estimate a logistic model that regresses OSDMY on control variables and the two compensation variables
(Panel A, Table 7 ). Based on the coefficients from this model, we compute a propensity score for each observation and then

Business
92
TABLE 7
Propensity Score Matching
Panel A: The Logit Model Estimates of the First Stage Panel B: Covariate Mean Comparison
Treatment Group Control Group
Dependent Variable ¼ OS(Dummy) OS(Dummy) ¼ OS(Dummy) ¼ 0 Comparison
1
Variables Estimate Std. Error Pr . z Mean Mean Diff. Pr . t
Intercept 0.0055 (0.0899) 0.9521

STOCKRATIO 0.0010 (0.0229) 0.9652 0.3310 0.3316 0.0006 0.9483
CASHRATIO 0.0259 (0.0214 ) 0.2540 0.1197 0.1201 0.0004 0.9247
INVEST_SALE 0.0001 (0.0003) 0.8380 14.9944 14.7207 0.2737 0.6159
SIZE 0.0141 (0.0083) 0.1174 7.1441 7.1674 0.0233 0.5333
MB 0.0025 (0.0021) 0.2706 2.9706 2.9695 0.0011 0.9910
INSTHLDG 0.0251 (0.0187 ) 0.2085 0.7006 0.7035 0.0029 0.6386
AQUALITY 0.4947 (0.1504 ) 0.0082 0.0508 0.0495 0.0013 0.2049
CFO 0.2368 (0.0310) , 0.0001 0.1108 0.1089 0.0019 0.6019
TANGIBIL 0.1161 (0.0266 ) 0.0014 0.2623 0.2620 0.0003 0.9644
KSTRUC 0.2105 (0.0332) 0.0001 0.1712 0.1692 0.0020 0.6655
INDKSTRUC 1.0946 (0.0791) , 0.0001 0.1766 0.1792 0.0026 0.2688
SLACK 0.0052 (0.0018) 0.0166 2.1859 2.0952 0.0907 0.5321
DIVDUM 0.1012 (0.0159) 0.0001 0.4613 0.4651 0.0038 0.7514
ZSCORE 0.1398 (0.0347 ) 0.0024 0.6524 0.6535 0.0011 0.8631
FIRMAGE 0.0003 (0.0002) 0.1381 24.8197 25.0038 0.1841 0.6416
ANALYSTS 0.0034 (0.0011) 0.0097 10.1658 10.4060 0.2402 0.3074
STD_INVEST 0.0095 (0.0005) , 0.0001 9.2752 8.9549 0.3203 0.1889
STD_CFO 0.3091 (0.1439) 0.0572 0.0554 0.0552 0.0002 0.8480
STD_REV 0.0968 (0.0529) 0.0971 0.1651 0.1629 0.0022 0.5308
OPCYCLE 0.0305 (0.0045) , 0.0001 4.5707 4.5728 0.0021 0.9040
LOSS 0.0142 (0.0148) 0.3617 0.2101 0.2119 0.0018 0.8582
n 7,462 2,511 2,511
R2 0.0858
The table reports the propensity score matching procedure. Panel A presents the first-stage logit regression estimates of the determinants of firms pursuing
a prospector strategy. Panel B reports the mean difference between covariates used in Panel A.
match each prospector-like observation (i.e., OSDMY ¼ 1), without replacement, to a defender–like observation (i.e., OSDMY ¼
0) with the closest propensity score based on a caliper width of 0.01. Our covariate analysis (Panel B, Table 7 ) shows that our
propensity score matching achieves a covariate balance between prospector- and defender-like firms to ensure that these firms
are similar across all other dimensions (including the compensation measures) except for the variable of interest (i.e., OS).
Continuing with our propensity matched procedure, we compare investment efficiency between firms with above and
below median CEO stock and equity compensation in both defender- and prospector-like companies and report the results in
Table 8. Specifically, we investigate whether firms’ propensity to over-investment increases when CEO stock compensation
(STOCKRATIO) increases for prospector-like firms (Panel A, Table 8) and whether firms’ propensity to under-investment
increases when CEO cash compensation (CASHRATIO) increases for defender-like firms (Panel B, Table 8). In Panel A, we
observe that for prospector-like firms, increasing CEO stock compensation translates in a statistically larger propensity to over-
invest, an increase from 28.39 percent to 32.26 percent probability, whereas for defender-like firms, increasing CEO stock
compensation has no effect on firms’ propensity to over-invest. In a similar vein, in Panel B, we observe increasing CEO cash
compensation has no effect on firms’ propensity to under-invest in prospector-like firms. However, for defender-like firms,
increasing CEO cash compensation translates in a statistically larger propensity to under-invest, an increase from 26.24 percent
to 29.62 percent probability. These results further confirm the results from our main analysis.

Business
93
CONCLUSION
This study examines the role of business strategy in influencing investment efficiency. Prospector and defender strategies
expose firms to different required levels of investment, monitoring, and managerial discretion, which have implications for

Business
94
TABLE 8
Mean Over- and Under-Investment Differences between High (Above the Median) and Low (Below the Median) Levels
of CEO Stock Compensation (STOCKRATIO) and Cash Compensation (CASHRATIO) for Defender- and Prospector-
Like Firms Based on a Propensity Score Matched Sample, Where OS(DUMMY) ¼ 0 Represents Defenders and
OS(Dummy) ¼ 1 Represents Prospectors
Panel A: Mean OVER(Dummy) Difference between Levels of CEO Stock Compensation
STOCKRATIO
Below Median Above Median Difference
OS(Dummy) ¼ Defenders ¼ 0 2,131 0.2812 0.2847 0.0035
OS(Dummy) ¼ Prospectors ¼ 1 2,246 0.2839 0.3226 0.0387**
Panel B: Mean UNDER(Dummy) Difference between Levels of CEO Cash Compensation

CASHRATIO
Below Median Above Median Difference
OS(Dummy) ¼ Defenders ¼ 0 2,119 0.2624 0.2962 0.0338*
OS(Dummy) ¼ Prospectors ¼ 1 2,041 0.2444 0.2230 0.0214
*, ** Represent significance at the 10 and 5 percent levels, respectively, using two-tailed tests.
This table reports the mean level of over- and under-investment across two ranks of CEO stock and cash compensation, respectively, for defender- and
prospector-like companies. For this analysis, we transform INVEFF to create two indicator variables. OVER(Dummy) is an indicator variable that takes a
value of 1 when INVEFF ¼ 2 and a value of 0 when INVEFF ¼ 0. UNDER(Dummy) is an indicator variable that takes a value of 1 when INVEFF ¼ 1 and a
value of 0 when INVEFF ¼ 0. To mitigate the issue of reduced sample size with few prospectors and defenders, we create an indicator variable,
OS(Dummy), where all companies with an OS score between 13 and 20 are identified as prospector-like and all companies with an OS score between 4 and
12 are identified as defender-like. Variables are defined in Appendix B.
managerial investment decisions. We first empirically demonstrate that prospectors exhibit greater information asymmetry,
proxied by the bid-ask spread, relative to defender firms. We also show that over- and under-investment have an adverse effect
on subsequent firm performance as indicated by declining ROA. In our main analysis, we find that firms with a prospector
strategy are more likely to over-invest, whereas firms following a defender strategy are more likely to under-invest, and these
results intensify when CEOs have more stock-based compensation in prospector firms and cash-based compensation in
defender firms. In additional analyses we find that within the subsample of prospector firms the likelihood of over-investment is
greater when their business strategy scores approach the upper end, relative to the lower-end, of the prospector strategy scores.
On the other hand, in the subsample of defender firms, the likelihood of under-investment is greater when their business
strategy scores are closer to the lower end, relative to the upper end, of the defender strategy scores. Our results are also robust
to controlling for other determinants of investment efficiency (e.g., managerial overconfidence, internal control weaknesses,
and overall risk), analyses of individual components of business strategy, year-by-year and industry-by-industry analyses,
ordered logit regression, analyses on investment component residuals as alternative dependent variables, controlling for lagged
investment residuals, first-differenced specifications, firm fixed-effects, and propensity score matching.
While our study responds to Biddle et al. (2009) by suggesting business strategy as the causal link between information
asymmetry and investment efficiency, there are several avenues worth noting for future research. Considering that firms with
different strategies are likely to adopt different corporate governance mechanism, future studies can explore the moderation
effect of corporate governance on the relationship between business strategy and investment efficiency. Further, it is also
interesting to investigate whether investors react differently (e.g., the cost of equity capital) to the firm’s investment efficiency
based on business strategy.
REFERENCES
Abel, A. B. 1983. Optimal investment under uncertainty. The American Economic Review 73 (1): 228–233.

Business
95
Aboody, D., and B. Lev. 2000. Information asymmetry, R&D, and insider gains. The Journal of Finance 55 (6 ): 2747–2766. Aggarwal,
R., and A. Samwick. 2006. Empire-builders and shirkers: Investment, firm performance, and managerial incentives. Journal of
Corporate Finance 12 (3): 489–515.

Business
96
Armstrong, C. S., and R. Vashishtha. 2012. Executive stock options, differential risk-taking incentives, and firm value. Journal of
Financial Economics 104 (1): 70–88.
Armstrong, C. S., I. D. Gow, and D. F. Larcker. 2013. The efficacy of shareholder voting: Evidence from equity compensation plans.
Journal of Accounting Research 51 (5): 909–950.
Barth, M. E., R. Kasznik, and M. F. McNichols. 2001. Analyst coverage and intangible assets. Journal of Accounting Research 39 (1): 1–
34.
Bentley, K. A., T. C. Omer, and N. Y. Sharp. 2013. Business strategy, financial reporting irregularities, and audit effort. Contemporary
Accounting Research 30 (2): 780–817.
Bentley, K. A., T. C. Omer, and B. J. Twedt. 2014. Does Business Strategy Impact a Firm’s Information Environment? Working paper,
UNSW Australia and Texas A&M University.
Bertrand, M., and A. Schoar. 2003. Managing with style: The effect of managers on firm policies. The Quarterly Journal of Economics
118 (4 ): 1169–1208.
Bhushan, R. 1989. Firm characteristics and analyst following. Journal of Accounting & Economics 11 (2/3): 255–274.
Biddle, G. C., G. Hilary, and R. S. Verdi. 2009. How does financial reporting quality relate to investment efficiency? Journal of
Accounting & Economics 48 (2/3): 112–131.
Bizjak, J. M., J. A. Brickley, and J. L. Coles. 1993. Stock-based incentive compensation and investment behavior. Journal of Accounting
& Economics 16 (1/3): 349–372.
Blanchard, O., F. Lopez-de-Silanes, and A. Shleifer. 1994. What do firms do with cash windfalls? Journal of Financial Economics 36 (3):
337–360.
Boyd, B. K., and A. Salamin. 2001. Strategic reward systems: A contingency model of pay system design. Strategic Management Journal
22 (8): 777–792.
Brockman, P., T. Ma, and J. Ye. 2015. CEO compensation risk and timely loss recognition. Journal of Business Finance & Accounting 42
(1/2): 204–236.
Byun, K. J., and C. Frey. 2012. The U.S. economy in 2020: Recovery in uncertain times. Monthly Labor Review U.S. Bureau of Labor
Statistics (January): 21–42.
Chang, H., J. Chen, W. M. Liao, and B. K. Mishra. 2006. CEOs’/CFOs’ swearing by the numbers: Does it impact share price of the firm?
The Accounting Review 81 (1): 1–27.
Chen, F., O. Hope, Q. Li, and X. Wang. 2011. Financial reporting quality and investment efficiency of private firms in emerging markets.
The Accounting Review 86 (4 ): 1255–1288.
Chen, K., Z. Chen, and K. Wei. 2011. Agency costs for free cash flows and the effect of shareholder rights on the implied cost of equity
capital. Journal of Financial and Quantitative Analysis 46 (1): 171–207.
Chen, M. A., D. T. Greene, and J. E. Owers. 2015. The costs and benefits of clawback provisions in CEO compensation. The Review of
Corporate Finance Studies 4 (1): 108–154.
Cheng, M., D. Dhaliwal, and Y. Zhang. 2013. Does investment efficiency improve after the disclosure of material weaknesses in internal
control over financial reporting? Journal of Accounting & Economics 56 (1): 1–18.
Cheng, S. 2004. R&D expenditures and CEO compensation. The Accounting Review 79 (2): 305–328.
Cho, T. S., and D. C. Hambrick. 2006. Attention patterns as mediators between top management team characteristics and strategic change:
The case of airline deregulation. Organization Science 17 (4 ): 453–469.
Coles, J. L., N. D. Daniel, and L. Naveen. 2006. Managerial incentives and risk-taking. Journal of Financial Economics 79 (2): 431–468.
Conant, J. S., M. P. Mokwa, and P. R. Varadarajan. 1990. Strategic types, distinctive marketing competencies and organizational
performance: A multiple measures-based study. Strategic Management Journal 11 (5): 365–383.
Covin, J. G. 1991. Entrepreneurial versus conservative firms: A comparison of strategies and performance. Journal of Management
Studies 28 (5): 439–462.
Cutillas Gomariz, M., and J. Sánchez Ballesta. 2014. Financial reporting quality, debt maturity and investment efficiency. Journal of
Banking & Finance 40 (3): 494–506.
Dechow, P., and I. Dichev. 2002. The quality of accruals and earnings: The role of accrual estimation errors. The Accounting Review 77
(Supplement): 35–59.
Denis, D., P. Hanouna, and A. Sarin. 2006. Is there a dark side to incentive compensation? Journal of Corporate Finance 12 (3): 467–
488.
Devers, C., G. McNamara, R. Wiseman, and M. Arrfelt. 2008. Moving closer to the action: Examining compensation design effects on
firm risk. Organization Science 19 (4 ): 548–566.
Eisdorfer, A., C. Giaccotto, and R. White. 2013. Capital structure, executive compensation, and investment efficiency. Journal of Banking
& Finance 37 (2): 549–562.

Business
97
Fama, E., and J. MacBeth. 1973. Risk, return and equilibrium: Empirical tests. Journal of Political Economy 81 (3): 607–636.
Fama, E., and K. French. 1997. Industry costs of equity. Journal of Financial Economics 43 (2): 153–193.
Fox-Wolfgramm, S. J., K. B. Boal, and J. G. Hunt. 1998. Organizational adaptation to institutional change: A comparative study of first-
order change in prospector and defender banks. Administrative Science Quarterly 43 (1): 87–126.

Business
98
Francis, J., A. H. Huang, S. Rajgopal, and A. Y. Zang. 2008. CEO reputation and earnings quality. Contemporary Accounting Research
25 (1): 109–147.
Gallemore, J., and E. Labro. 2015. The importance of the internal information environment for tax avoidance. Journal of Accounting &
Economics 60 (1): 149–167.
Gomez-Mejia, L. R. 1992. Structure and process of diversification, compensation strategy, and firm performance. Strategic Management
Journal 13 (5): 381–397.
Gomez-Mejia, L. R., T. M. Welbourne, and R. M. Wiseman. 2000. The role of risk sharing and risk taking under gainsharing. The
Academy of Management Review 25 (3): 492–507.
Goodman, T., M. Neamtiu, N. Shroff, and H. White. 2014. Management forecast quality and capital investment decisions. The
Accounting Review 89 (1): 331–365.
Gow, I. D., G. Ormazabal, and D. J. Taylor. 2010. Correcting for cross-sectional and time-series dependence in accounting research. The
Accounting Review 85 (2): 483–512.
Graham, R. C. Jr., and K. D. Frankenberger. 2000. The contribution of changes in advertising expenditures to earnings and market values.
Journal of Business Research 50 (2): 149–155.
Grullon, G., G. Kantas, and J. P. Weston. 2004. Advertising, breadth of ownership, and liquidity. Review of Financial Studies 17 (2):
439–461.
Hambrick, D. 1983. Some tests of the effectiveness and functional attributes of Miles and Snow’s strategic types. Academy of
Management Journal 26 (1): 5–26.
Hambrick, D. 2003. On the staying power of Miles and Snow’s defenders, analyzers and prospectors. The Academy of Management
Executive 17 (4 ): 115–118.
Hart, O., and J. Moore. 1995. Debt and seniority: An analysis of the role of hard claims in constraining management. The American
Economic Review 85 (3): 567–585.
Hayashi, F. 1982. Tobin’s marginal q and average q: A neoclassical interpretation. Econometrica 50 (1): 213–224.
Heaton, J. B. 2002. Managerial optimism and corporate finance. Financial Management 31 (2): 33–45.
Higgins, D., T. C. Omer, and J. D. Phillips. 2015. The influence of a firm’s business strategy on its tax aggressiveness. Contemporary
Hirshleifer, D. 1993. Managerial reputation and corporate investment decisions. Financial Management 22 (2): 145–160.
Holmströ m, B. 1979. Moral hazard and observability. The Bell Journal of Economics 10 (1): 74–91.
Holmströ m, B., and P. Milgrom. 1991. Multitask principal-agent analyses: Incentive contracts, asset ownership, and job design. The
Journal of Law, Economics, & Organization 7 (Supplement): 24–52.
Hubbard, R. G. 1998. Capital market imperfections and investment. Journal of Economic Literature 36 (1): 193–225.
Huddart, S. J., and B. Ke. 2007. Information asymmetry and cross-sectional variation in insider trading. Contemporary Accounting
Research 24 (1): 195–232.
Ittner, C., and D. Larcker. 1997. Quality strategy, strategic control systems, and business performance. Accounting, Organizations and
Society 22 (3/4 ): 295–314.
Ittner, C., D. Larcker, and M. Rajan. 1997. The choice of performance measures in annual bonus contracts. The Accounting Review 72 (2):
231–255.
Jensen, M. 1986. Agency costs of free cash flow, corporate finance, and takeovers. The American Economic Review 76 (2): 323–329.
Jensen, M., and W. Meckling. 1976. Theory of the firm: Managerial behavior, agency costs, and ownership structure. Journal of Financial
Economics 3 (4 ): 305–360.
Jung, B., W. Lee, and D. Weber. 2014. Financial reporting quality and labor investment efficiency. Contemporary Accounting Research
31 (4 ): 1047–1076.
Kabanoff, B., and S. Brown. 2008. Knowledge structures of prospectors, analyzers, and defenders: Content, structure, stability, and
performance. Strategic Management Journal 29 (2): 149–171.
Kim, K., E. Mauldin, and S. Patro. 2014. Outside directors and board advising and monitoring performance. Journal of Accounting &
Economics 57 (2/3): 110–131.
Klein, A. 1998. Firm performance and board committee structure. The Journal of Law & Economics 41 (1): 275–303.
Kotha, S., and A. Nair. 1995. Strategy and environment as determinants of performance: Evidence from the Japanese machine tool
industry. Strategic Management Journal 16 (7): 497–518.
Lambert, R. A. 1986. Executive effort and selection of risky projects. The RAND Journal of Economics 17 (1): 77–88. Lundstrum, L.
2002. Corporate investment myopia: A horserace of the theories. Journal of Corporate Finance 8 (4): 353–371. Malmendier, U., and
G. Tate. 2005. CEO overconfidence and corporate investment. The Journal of Finance 60 (6 ): 2661–2700. Malmendier, U., and G.
Tate. 2008. Who makes acquisitions? CEO overconfidence and the market’s reaction. Journal of Financial
Economics 89 (1): 20–43.

Business
99
Malmendier, U., and G. Tate. 2009. Superstar CEOs. The Quarterly Journal of Economics 124 (4 ): 1593–1638.
McConnell, J. J., and C. J. Muscarella. 1985. Corporate capital expenditure decisions and the market value of the firm. Journal of
Financial Economics 14 (3): 399–422.

Business
10
0 0
McDaniel, S., and J. Kolari. 1987. Marketing strategy implications of the Miles and Snow strategic typology. Journal of Marketing 51
(4 ): 19–30.
McNichols, M. 2002. The quality of accruals and earnings: The role of accrual estimation errors: Discussion. The Accounting Review 77
(Supplement): 61–69.
Mengüç, B., and S. Auh. 2008. The asymmetric moderating role of market orientation on the ambidexterity-firm performance relationship
for prospectors and defenders. Industrial Marketing Management 37 (4 ): 455–470.
Meyers-Levy, J. 1989. Gender differences in information processing: A selectivity interpretation. In Cognitive and Affective Responses to
Advertising, edited by Cafferata, P., and M. A. Tybout, 219–260. Lexington, MA: Lexington Press.
Miles, R. E., and C. C. Snow. 1978. Business Strategy, Structure and Process. New York, NY: McGraw-Hill.
Miles, R. E., and C. C. Snow. 2003. Business Strategy, Structure and Process. Stanford, CA: Stanford University Press.
Modigliani, F., and M. H. Miller. 1958. The cost of capital, corporation finance, and the theory of investments. The American Economic
Review 48 (3): 261–297.
Myers, S. C. 1977. Determinants of corporate borrowing. Journal of Financial Economics 5 (2): 147–176.
Myers, S. C., and N. S. Majluf. 1984. Corporate financing and investment decisions when firms have information that investors do not
have. Journal of Financial Economics 13 (2): 187–221.
Naiker, V., F. Navissi, and V. G. Sridharan. 2008. The agency cost effects of unionization on firm value. Journal of Management
Parnell, J. A., and P. Wright. 1993. Generic strategy and performance: An empirical test of the Miles and Snow typology. British Journal
of Management 4 (1): 29–36.
Petersen, M. 2009. Estimating standard errors in finance panel data sets: Comparing approaches. Review of Financial Studies 22 (1): 435–
480.
Prawitt, D., N. Sharp, and D. Wood. 2012. Internal audit outsourcing and the risk of misleading or fraudulent financial reporting: Did
Sarbanes-Oxley get it wrong? Contemporary Accounting Research 29 (4): 1109–1136.
Rajagopalan, N. 1997. Strategic orientations, incentive plan adoptions, and firm performance: Evidence from electric utility firms.
Strategic Management Journal 18 (10): 761–785.
Rajagopalan, N., and S. Finkelstein. 1992. Effects of strategic orientation and environmental change on senior management reward
systems. Strategic Management Journal 13 (S1): 127–141.
Rajan, R. G., and L. Zingales. 1998. Financial dependence and growth. The American Economic Review 88 (3): 559–586.
Rego, S. O., and R. Wilson. 2012. Equity risk incentives and corporate tax aggressiveness. Journal of Accounting Research 50 (3): 775–
810.
Roll, R. 1986. The hubris hypothesis of corporate takeovers. The Journal of Business 59 (2): 197–216.
Sabherwal, R., and Y. E. Chan. 2001. Alignment between business and IS strategies: A study of prospectors, analyzers and defenders.
Information Systems Research 12 (1): 11–33.
Said, A., H. Hassab-Elnaby, and B. Wier. 2003. An empirical investigation of the performance consequences of nonfinancial measures.
Journal of Management Accounting Research 15 (1): 193–223.
Shavell, S. 1979. On moral hazard and insurance. The Quarterly Journal of Economics 93 (4 ): 541–562.
Shleifer, A., and R. W. Vishny. 1989. Management entrenchment: The case of manager-specific investments. Journal of Financial
Economics 25 (1): 123–139.
Shortell, S. M., and E. J. Zajac. 1990. Perceptual and archival measures of Miles and Snow’s strategic types: A comprehensive assessment
of reliability and validity. Academy of Management Journal 33 (4 ): 817–832.
Snow, C. C., and D. C. Hrebiniak. 1980. Measuring organizational strategies: Some theoretical and methodological problems. The
Academy of Management Review 5 (4 ): 527–538.
Snow, C., and D. Hambrick. 1980. Measuring organizational strategies: Some theoretical and methodological problems. The Academy of
Management Review 5 (4 ): 527–538.
Stein, J. 2003. Agency, information and corporate investment. In The Handbook of the Economics of Finance, edited by Constantinides,
G., M. Harris, and R. Stulz, 111–165. New York, NY: Elsevier/North-Holland.
Stulz, R. M. 1990. Managerial discretion and optimal financing policies. Journal of Financial Economics 26 (1): 3–27.
Thomas, A. S., and K. Ramaswamy. 1996. Matching managers to strategy: Further tests of the Miles and Snow typology. British Journal
of Management 7 (3): 247–261.
Yermack, D. 2006. Flights of fancy: Corporate jets, CEO perquisites, and inferior shareholder returns. Journal of Financial Economics 80
(1): 211–242.
Yoshikawa, H. 1980. On the ‘‘q’’ theory of investment. The American Economic Review 70 (4 ): 739–743.
Zahra, S. A., R. L. Priem, and A. A. Rasheed. 2005. The antecedents and consequences of top management fraud. Journal of Management
31 (6 ): 803–828.
Zammuto, R. 1988. Organizational adaptation: Some implications of organizational ecology for strategic choice. Journal of Management
Studies 25 (2): 105–120.

Business
10
1 1
Zammuto, R. F., and K. S. Cameron. 1985. Environmental decline and organizational response. In Research in Organizational Behavior,
edited by Cummings, L. L., and B. M. Staw, 223–262. Greenwich, CT: JAI Press.

Business
10
2 2
APPENDIX A
To ensure the construct validity of our business strategy scores, we randomly choose, from our dataset, two prospector
firms with the scores of 17 to 20 and two defender firms from the scores of 4 to 7, and investigate whether they are
representatives of innovation and efficiency strategies based on the strategic information provided in their SEC 10-K reports.
For instance, the business strategy scores in 2009 for Landec Corporation and Tupperware Brands Corporation (in the
rubber and plastic products industry) are 7 and 18, respectively, and are thus more aligned with a defender strategy and a
prospector strategy, respectively. Based on the SEC 10-K filings, Landec Corporation combines its food packaging
technologies with the capabilities of a large national food supplier, which, together with automating the food processing plant
with state-of-the-art vegetable processing equipment and operating a large, low cost facility, allowed for the cost efficient
nationwide delivery of fresh produce products. Whereas Tupperware Brands Corporation relies on a large employee base
around the world, in manufacturing kitchenware that is design centric, to address differences in cultures, lifestyles, and tastes
and invests heavily in marketing as one of the principal bases of competition, symbolic of a prospector strategy.
In the machinery industry, AG&E Holdings Inc. (business strategy score in 2009 ¼ 4 ) and Riverbed Technology, Inc.
(business strategy score in 2009 ¼ 19), are classified in our data as a defender and prospector, respectively. AG&E Holdings
Inc. experiences significant competition based on price and views the provision of reliable and cost-efficient video displays as a
strategy to keep rivals at bay, and is committed to automating the manufacturing processes and reducing expenditure (e.g.,
employing few personnel) for a more competitive cost structure, symbolic of a defender strategy. Whereas, Riverbed
Technology, Inc. believes its competitive position lies in the product performance of comprehensive network solutions,
extension of its technological advantage and product line, and increased market awareness supported by the large number of
locations and employees worldwide, symbolic of a prospector strategy.

Business
10
3 3
APPENDIX B
Definition and Measurement of Variables
Panel A: Main Dependent and Test Variables
Variable Definition
INVEFF Total investment efficiency firm-year observations comprising residuals from regressing lead investment
(INVESTtþ1) against sales growth (SALESGROWTH). Residuals are subsequently quartile ranked by each year
and SIC two-digit industry to assign a score of 0, 1, or 2 to each firm-year observation.
INVEFF ¼ 2 Over-investment comprising firm-year observations in Quartile 4 of INVEFF.
INVEFF ¼ 1 Under-investment comprising firm-year observations in Quartile 1 of INVEFF.
INVEFF ¼ 0 Normal investment (reference category) comprising firm-year observations in Quartiles 2 and 3 of INVEFF.
OS Business strategy score (between 4 and 20) constructed as the sum of quintile ranks in each year and SIC two-
digit industry of the following four variables described in Panel C: EMPS5, REV5, SGA5, and STDEMP5.
OS_PROSPECTOR Prospector strategy comprising OS firm-year observations with scores of 17 to 20.
OS_DFENDER Defender strategy comprising OS firm-year observations with scores of 4 to 7.
CASHRATIO The ratio of CEO cash compensation to total CEO compensation.
STOCKRATIO The ratio of the CEO stock and option compensation to total CEO compensation.
HOLDER67 An indicator variable coded 1 if a CEO failed to exercise his/her vested options when the options were more than
67 percent in-the-money at least twice during the sample period.
LONGHOLDER An indicator variable coded 1 if a CEO holds his/her options at least once until expiration.
Panel B: Variables Used to Construct Dependent Variable

Variable Definition
INVEST Total investment, which is calculated as [(acquisition expenditure þ capital expenditure) (cash receipts from
sale of property, plant and equipment)] 100/lagged total assets.
SALESGROWTH The percentage change in sales from years t 1 to t.
Panel C: Variables Used to Construct Test Variable

Variable Definition
EMPS5 The ratio of the number of employees to sales computed over a rolling prior five-year average.
REV5 Annual percentage change in sales computed over a rolling prior five-year average.
SGA5 The ratio of selling, general and administrative expenditure to sales computed over a rolling prior five-year
average.
STDEMP5 Standard deviation of the number of employees computed over a rolling prior five-year period.
Panel D: Control Variables

Variable Definition
INVEST_SALE Total investment divided by sales.
SIZE The logarithm of total assets.
MB The market-to-book ratio.
INSTHLDG The percentage of firm shares held by institutional investors.
AQUALITY Accrual quality is based on Dechow and Dichev (2002), modified by McNichols (2002), and is calculated as the
standard deviation (et 1, et 2, et 3, et 4 ) of residuals from regressing working capital accruals on changes in
cash flow in year t 1, t, and tþ1, and changes in revenue, and property, plant and equipment in each Fama
and French (1997) industry-year.
CFO Cash flow from operations divided by sales.
TANGIBIL Tangibility is the ratio of property, plant, and equipment divided by total assets.
KSTRUC The ratio of long-term debt to the sum of long-term debt and market value of equity.
INDKSTRUC Industry K-structure is the average value of KSTRUC for all firms in the same SIC two-digit industry.
SLACK The ratio of cash to property, plant, and equipment.
DIVDUM An indicator variable coded 1 if a dividend is paid, and 0 otherwise.

Business
10
4 4
ZSCORE The score of 3.3 Pre-Tax Income þ Sales þ 0.25 Retained Earnings þ 0.5 Working Capital, which
together is scaled by total assets and then decile ranked.
FIRMAGE The difference between the first year when the firm appears in CRSP and the current year.
(continued on next page)

Business
10
5 5
APPENDIX B (continued)
Variable Definition
ANALYSTS The number of analysts following a firm.
STD_INVEST Standard deviation of investment from year t 5 to t 1.
STD_CFO Standard deviation of cash flow from operations divided by average total assets from year t 5 to t 1.
STD_REV Standard deviation of sales revenue divided by average total assets from year t 5 to t 1. OPCYCLE
The log of receivables to sales plus inventory to cost of goods sold (COGS) multiplied by 360.
LOSS An indicator variable coded 1 if net income before extraordinary items is negative, and 0 otherwise.


Business Strategy, Over - (Under)

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Business Strategy, Over - (Under)

Uploaded by

Copyright:

Available Formats

JOURNAL OF MANAGEMENT ACCOUNTING RESEARCH American Accounting Association

Vol. 29, No. 2 DOI: 10.2308/jmar-51537

Business Strategy, Over- (Under-) Investment,

Editor’s note: Accepted by Ranjani Krishnan.

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

RELATED LITERATURE AND HYPOTHESES DEVELOPMENT

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

METHODOLOGY, MEASUREMENTS, AND DATA

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Test Variable: Business Strategy

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Panel B: Year Distribution of Sample Firms

Panel C: Industry Distribution of Sample Firms

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Panel B: Correlation Variables SLACK to LOSS

Journal of Management Accounting Research Journal of Management Accounting Research

Information Asymmetry and Future Performance

Multinomial Logistic Model

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Intercept 0.0703 (0.4041) 0.8620 1.0946 (0.3794 ) 0.0039

Analyses of Prospectors versus Defenders

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Intercept 0.5022 (0.4501) 0.2646 0.8962 (0.5289) 0.0902

Panel B: Interacting Only STOCKRATIO with OS

Intercept 0.6477 (0.4529) 0.1527 1.2983 (0.4998) 0.0094

Panel C: Interacting Only CASHRATIO with OS

Intercept 0.8045 (0.4584 ) 0.0792 1.0473 (0.5071) 0.0389

Journal of Management Accounting Research Journal of Management Accounting Research

Controlling for Other Determinants of Sub-Optimal Investment Decisions

Ordered Logit Regression

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

OS 0.0158 (0.0076 ) 0.0362 0.0302 (0.0065) , 0.0001

Analysis of Investment Components

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Year-by-Year and Industry-by-Industry Analyses

Controlling for Lagged Investment Residuals

Controlling for Firm Fixed-Effects

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Propensity Score Matching

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Variables Estimate Std. Error Pr . z Mean Mean Diff. Pr . t

Intercept 0.0055 (0.0899) 0.9521

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Panel B: Mean UNDER(Dummy) Difference between Levels of CEO Cash Compensation

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research

Journal of Management Accounting Research Journal of Management Accounting Research