The effect of corporate governance on the relationship between performance and competition

Abstract This paper examines the effect of corporate governance on the relationship between performance and market competition. We use changes in import tariffs as exogenous shocks to product market competition to examine how the effect of these shocks on performance varies with corporate governance. We find that elevated product market competition due to import tariff cuts results in significant performance deterioration for firms with strong corporate governance, but little effect or even a significant positive effect on performance for firms with poor governance. We further find that these effects are much stronger for nonexporting firms and small firms because they do not have the opportunity/resources to soften the impact of increased competitive pressure. Our findings suggest that elevated market competition helps to reduce managerial entrenchment/slack, which can offset the adverse effects of increased competitive pressure, especially for nonexporting firms and small firms. The findings lend support to the hypothesis that managerial slack is inversely related to industry competitive pressure and, hence, that product market competition and internal corporate governance are substitutes for each other.