Overinvesting via delayed exit: An empirical investigation of the cost of excessive continuation

Firm entry and exit decisions are central to theories of market organization and the firm, and to the efficiency of a competitive market environment. Timely exit by “inefficient” firms is essential for the reallocation of economic resources from lower-value to higher-value users. If firm performance continues to decline it may become optimal to dismantle the firm and release its assets to higher-valued outside uses. However, different stakeholders in the firm may disagree about the exit decision and its timing. In some cases stockholders and/or managers with control rights may prefer continued operation of the firm even when the liquidation value of the firm exceeds its continuation value. In this paper we investigate the problem of excessive continuation among U.S. firms. Using firm-level data for the period 1970-2011 we observe that on average 13.6% of the U.S. firms continued excessively each year. The average duration of excessive continuation was 3.6 years with costs for such firms of about 15.9% in cumulative loss of returns on assets. We employ a discrete-time hazard model using multi-period Logit regressions and find that greater liquidity, greater debt maturity, weaker debt covenants and greater shareholder-management agency problem are all positively associated with excessive continuation.