Subordinates’ Horizon, Internal Governance and Corporate Investment Efficiency

In this paper, we investigate whether internal governance mitigates any investment inefficiencies. Internal governance is defined as the process through which younger subordinate executives provide monitoring role over the CEO and affect corporate decisions. Subordinate executives have longer decision horizon compared to the CEO and have the incentives to refrain from taking value-destroying actions for the benefit of short-term performance. Key subordinate executives also possess a great influence on a firm’s decision making process. Using the key subordinate executives’ horizon relative to CEO horizon as a measure of internal governance, we analyze whether internal governance mitigates any under- or over-investment problem. We use U.S. data and find that firms with better internal governance suffer from less under-investment problem. Specifically, we find that internal governance is positively associated with the level of investment for firms that are likely to under-invest. However, we do not find evidence that internal governance mitigates the over-investment problem. Overall, the results of our study provide supporting evidence that, for firms suffering an under-investment problem, bottom-up internal governance is effective in improving investment efficiency. Our results remain consistent regardless of the types of investment or the method of measuring investment efficiency.