Managerial job security and firm diversification

Abstract

We analyze the effects of managerial job security on firm diversification. Our results indicate that enacting legal protection for managers’ employment is conducive to less corporate diversification. Our findings suggest that, in relation to managerial entrenchment and empire-building theories, hedging against employment risk is more likely to be the primary factor for managers when deciding to conduct firm diversification. Consistent with the explanation of agency theory in relation to firm diversification, we also document that refocusing firms increase firm value after enacting the implied-contract exception. The incremental firm value likely reflects the improved efficiency of capital allocation across divisions, as we find that firms increase the efficiency of their capital allocation after the adoption of the law.