Corporate Governance and Real Investment Decisions

Within a broad sample of US manufacturing firms, we find that, controlling for investment opportunities and financial constraints, increased governance quality is associated with higher levels of investment. Increased governance quality is also associated with greater responsiveness of investment to investment opportunities, better firm performance and higher marginal product of capital. Our evidence suggests that better corporate governance drives managers to invest more, and to exert more effort in finding highly productive investment projects and in managing their investment efficiently. Poorly governed firms invest less, implying that they underinvest rather than overinvest. Their low marginal product of capital implies that they invest in less productive assets. Overall, our evidence is consistent with governance mechanisms mitigating problems stemming from managers seeking the 'quiet life'. We find no indication that the firm's governance quality is endogenous to its growth opportunities in our sample. Overall, the results suggests that better governance quality improves the efficiency of capital allocation within firms, and that lax governance produces underinvestment rather than overinvestment