When does Competition Mitigate Agency Problems?
This paper examines how the performance correlation of firms in an industry affects the degree to which product market competition mitigates agency problems. Consistent with theory, I find that in industries with high firm performance correlation, product market competition reduces the adverse effect of business combination (BC) laws on firm operating performance and thus substitutes for corporate governance. In contrast, in industries with low performance correlation, all firms experience a decline in operating performance after the passage of BC laws. Moreover, I find similar results for stock prices when examining the stock market reactions to the first newspaper reports of BC laws. Overall, my evidence suggests that the disciplining effect of competition depends positively on an industry’s performance correlation.