Conclusions
This paper analyzes the effect of managerial diversion on product market performance in a Cournot model. The model predicts that managerial diversion can boost product market performance by motivating the manager to compete more aggressively in product markets. In this sense, managerial diversion serves to complement other incentive mechanisms and may positively impact shareholder value. Consistent with the rent-seeking behavior of managerial diversion, our model predicts that excessive managerial diversion harms firm performance. We then test our model with data. In our empirical analysis, SOEs in China are well representative of firms with weak incentive mechanisms and corporate governance. Our results show that, for SOEs, managerial diversion has a positive effect on market share expansion and that the relation between diversion and profits is inverse U-shaped. The effects of diversion on product market performance and profits are mainly negative for private firms. Our study echoes one view in law and economics literature that managerial diversion may not necessarily be harmful to shareholder value. In firms with incentive problems or weak corporate governance, moderate diversion can motivate managers to work harder in the interest of shareholders. Our finding that the effect of diversion tends to be negative for firms with good incentive mechanisms and strong corporate governance is in line with the predominant current view that diversion should be discouraged and regulated. To summarize, our study suggests that the effect of diversion varies across firms with different incentive mechanisms, corporate governance, and extent of diversion.
