Firm Rigidities and the Decline in Growth Opportunities

As public firms exploit their growth opportunities following their initial public offering, their assets in place increase, and they organize themselves optimally to operate these assets efficiently, which requires a more formal and less flexible organization than to generate new growth opportunities. Our theory predicts that, as a result of these inflexibilities, firms fail to fully replace their growth opportunities, so that their Tobin’s q falls with age and they invest less as they grow older. With our theory, competition in the market for corporate control and capital markets monitoring increase the rate of decrease in Tobin’s q, while product and labor market competition slow it down. We find empirical support for these predictions. We also find evidence that the decline in q is related to firm rigidities. The Internet appendix is available at http://dx.doi.org/10.1287/mnsc.2016.2478. This paper was accepted by Gustavo Manso, finance.