The Impact of Operational Diversification and Investment Opportunities on the Relationship between Cost of Capital and CEO Change

Document Type : Research Paper


Assistant Prof., Department of Accounting, Faculty of Economics and Administrative Sciences, Lorestan University, Khoram Abad, Iran.


Objective: The opportunistic approach of managers leads to decisions on personal interests and the imposition of costs on the part of shareholders through increased agency costs. This paper, aims to examine the interaction between cost of capital and manager change based on operational diversification and investment opportunities.
Methods: To empirically examine this effect, data on companies listed on the Tehran Stock Exchange for the period of 2009 to 2018 were collected and a hybrid data regression model was used to test the research hypotheses.
Results: The results of the research show that cost of capital (expected returns) and investment opportunities have a significant effect on management turnover. On the other hand, we do not find evidence on the impact of under-investment and operational diversification on the possibility of CEO change. Furthermore, the interactive effect of investment opportunities and cost of capital on management turnover is also confirmed. Finally, our results Indicate that the change of CEO is a function of the interactive effect of operational diversification and cost of capital.
Conclusion: Managerial opportunism and inefficiency of investment increase the cost of corporate capital because the manager's inappropriate decision leads to an increase in the risk of wrong choices for investors. Changing the managerial decision approach leads to the transmission of information to shareholders in order to maintain or change management.


Aggarwal, R. K., & Samwick, A. A. (2003). Why do managers diversify their firms? Agency reconsidered. The Journal of Finance, 58(1), 71–118.
Ahmadpor, A., Esabat Tabari, E., Talebtabar, M. (2015). Earnings Quality and CEO Tenure. Empirical Research in Accounting, 5(2), 1-14. (in Persian)
Albuquerque, R., & Wang, N. (2008). Agency conflicts, investment, and asset pricing. Journal of Finance, 63(1), 1–40.
Amihud, Y., & Lev, B. (1981). Risk reduction as a managerial motive for conglomerate mergers. The Bell Journal of Economics, 12(2), 605–617.
Aoki, M. (2010). Corporations in Evolving Diversity, Cognition, Governance, and Institutions. Oxford University Press, Oxford, NY.
Armstrong, C., Core, J., Taylor, D. & Verrecchia, R. (2011). When does information asymmetry affect the cost of capital? Journal of Accounting Research, 49 (1), 1-40.
Ashbaugh-Skaife, H., Collins, D. W., Kinney Jr, W. R. & Lafond, R. (2009). The effect of SOX internal control deficiencies on firm risk and cost of equity. Journal of Accounting Research, 47(1), 1–43.
Bertrand, M. & Mullainathan, S. (2001). Are CEOs rewarded for luck? The ones without principals are. The Quarterly Journal of Economics, 116(3), 901–932.
Best, R. W., Hodges, C. W. & Lin, B.X. (2004). Does information asymmetry explain the diversification discount? Journal of Financial Research, 27(2), 235–249.
Bizjak, J. M., Brickley, J. A. & Coles, J. L. (1993). Stock-based incentive compensation and investment behavior. Journal of Accounting and Economics, 16(1-3), 349–372.
Brickley, J. (2003). Empirical research on CEO turnover and firm-performance: a discussion. Journal of Accounting and Economics, 36(1-3), 227–233.
Bushman, R., Dai, Z. & Wang, X. (2010). Risk and CEO turnover. Journal of Financial Economics, 96(3), 381–398.
Callen, J. L., Segal, D. & Hope, O.K. (2010). The pricing of conservative accounting and the measurement of conservatism at the firm-year level. Review of Accounting Studies, 15, 145–178.
Chen, G. & Keung, E. C. (2018). Corporate diversification, institutional investors and internal control quality. Journal of Accounting and Finance, 58(3), 751-786.
Choi, J.H., & Lee, W.J. (2013). Association between Big 4 auditor choice and cost of equity capital for multiple-segment firms. Working paper (Hong Kong Polytechnic University).
Deng, S., Intintoli, V., Zhang, A. (2019). CEO Turnover, Information Uncertainty, and Debt Contracting. Quarterly Journal of Finance, 9(2), 1- 54.
Dow, J. (2013). Boards, CEO entrenchment, and the cost of capital. Journal of Financial Economics, 110(3), 680-695.
Duchin, R. (2010). Cash holdings and corporate diversification. Journal of Finance, 65(3), 955–992.
Easton, P. D., Monahan, S. J. (2005). An evaluation of accounting-based measures of expected returns. The Accounting Review, 80(2), 501–538.
Faccio, M. (2006). Politically connected firms. The American Economic Review, 96(1), 369–386.
Fan, J. P. H., Wei, K. C. J. & Xu, X. (2011). Corporate finance and governance in emerging markets: a selective review and an agenda for future research. Journal of Corporate Finance, 17(2), 207–214.
Garmaise, M. J., & Liu, J. (2005). Corruption, firm governance, and the cost of capital. Working paper (University of California).
Giannetti, M., & Simonov, A. (2006). Which investors fear expropriation? Portfolio choices. Journal of Finance, 61(3), 1507–1547.
He, X. I. (2009). Corporate diversification and firm value: evidence from post-1997 data. International Review of Finance, 9(4), 359–385.
Hoechle, D., Schmid, M., Walter, I., & Yermack, D. (2012). How much of the diversification discount can be explained by poor corporate governance? Journal of Financial Economics, 103(1), 41–60.
Hogan, C. E., and Lewis, C. M. (2005). Long-run investment decisions, operating performance, and shareholder value creation of firms adopting compensation plans based on economic profits. Journal of Financial and Quantitative Analysis, 40(4), 721–745.
Hsu, Ch., Novoselov, K.E., & Wang, R. (2017). Does Accounting Conservatism Mitigate the Shortcomings of CEO Overconfidence? The Accounting Review, 92 (6). 77-101.
Hu, J. & Lin, Z. (2015). The implied cost of equity capital, corporate investment and chief executive officer turnover. Account Finance, 55(4), 1041-1070.
Huson, M.R., Parrino, R. and Starks, L.T. (2001). Internal monitoring mechanisms and CEO turnover: A long term perspective. Journal of Finance, 56(6), 2265-2297.
Iturriaga, F.J.L., & Crisostomo, V.L. (2010). Do Leverage, Dividend Payout, and Ownership Concentration Influence Firms’ Value Creation? Emerging Markets Finance and Trade, 46 (3), 80 – 94.
Jensen, M. C. & Murphy, K. J. (1990). Performance pay and top-management incentives. The Journal of Political Economy, 98(2), 225–264.
Jensen, M., & Meckling, W. H. (1976). Theory of the firm: managerial behavior, and ownership structure. Journal of Financial Economics, 3(4), 305–360.
Khosh Tienat, M., Zamani Far, L., Dehghan Nayyari, M. (2018). Relationship between financial indicators and manager change. Financial Accounting and Audit Research, 10 (37), 107-130. (in Persian)
Lambert, R. I., Leuz, C. H. & Verrecchia, R. O. (2007). Accounting information, disclosure, and the cost of capital. Journal of Accounting Research, 45(2), 385–420.
Laux, V. (2012). Stock option vesting conditions, CEO turnover, and myopic investment. Journal of Financial Economics, 106(3), 513-526.
Lombardo, D., & Pagano, M. (2002). Law and equity markets: a simple model. in: J. Mccahery, P. Moerland, T. Raaijmakers, L. Renneboog, eds., Corporate Governance Regimes: Convergence and Diversity (Oxford University Press, New York), 343–362.
Mavis, C.P., Alexandridis, G. & Doukas, J.A. (2014). Does CEO Turnover Improve Investment Performance? In: European Financial Management Association, Rome, Italy, 2014, 6-25.
Myers, S., & Majluf, N. (1984). Corporate financing and investment decisions when firms have information that investors do not have. Journal of Financial Economics, 13(2), 187–221.
Palepu, K. (1985). Diversification strategy, profit performance and the entropy measure. Strategic Management Journal, 6(3), 239–255.
Patatoukas, P. N., & Thomas, J. K. (2016). Placebo tests of conditional conservatism. The Accounting Review, 91 (2), 625–648.
Philippon, T. (2006). Corporate governance over the business cycle. Journal of Economic Dynamics and Control, 30(11), 2117–2141.
Rashidi, M. (2019). Pricing of Information Distribution Based on Comparability and Market Inefficiency. Financial Research Journal, 20(4), 531- 553. (in Persian)
Rezaei, F., Chavoshi Nia, K. (2014). Product Diversification (Related/Unrelated), Ownership Structure and Capital Structure. Financial Research Journal, 16(2), 271-288. (in Persian)
Rovshandel Arbatani, T., Shirvani Naghani, M. (2015). Introduction of a Model for Improving the Financial Performance of the Organization, with an Emphasis on the Role of “Human Resources Composition” and “Management Stability”. Financial Research Journal, 17(2), 199-218. (in Persian)
Sajadi, H., Nickar, J., Hajizaddeh, S. (2018). A Study of Different Aspects of the Company's Growth in Different Periods of Product Diversification. Journal of Accounting Advances, 10(1), 95-121. (in Persian)
Scharfstein, D., and Stein, J. (2000). The dark side of internal capital markets: divisional rent seeking and inefficient investment. Journal of Finance, 55(6), 2537–2567.
Schmid, M. M., & Walter, I. (2009). Do financial conglomerates create or destroy economic value? Journal of Financial Intermediation, 18(2), 193–216.
Shleifer, A., & Vishny, R. W. (1989). Management entrenchment: the case of manager specific investments. Journal of Financial Economics, 25(1), 123–139.
Smith, C. W., & Watts, R. L. (1992). The investment opportunity set and corporate financing, and compensation policies. Journal of Financial Economics, 32(3), 263–292.
Tong, Z. (2008). Firm Diversification and the Value of Corporate Cash Holdings. Journal of Corporate Finance, 17 (3), 741- 758.
Visintin, F., Pittino, D., Minichilli, A. (2017). Financial performance and non‐family CEO turnover in private family firms under different conditions of ownership and governance. Corporate Governance: An International Review, 25(5), 312-337.