Firm Life Cycle, Corporate Risk-Taking and Investor Sentiment

Accounting and Finance
Firm life cycle, corporate risk-taking and investor

sentiment
Ahsan Habiba, Mostafa Monzur Hasanb

a
School of Accountancy, Massey University, Auckland, New Zealand
b
School of Economics and Finance, Curtin University, Perth, WA, Australia
Abstract
This study investigates the corporate risk-taking and the performance

consequences at different stages of the firm life cycle. We find that risk-
taking is higher in the introduction and decline stages of the life cycle, but
lower in the growth and mature stages. We also find that risk-taking during
introduction and decline stage (growth and maturity stage) affects future
performance adversely (positively). We also document that managerial
risk-taking propensities increase during periods of high investor sentiment
and firms in different life cycle stages respond to sentiment differently.
Collectively, these results suggest that the firm life cycle has explanatory
power for corporate risk-taking behaviour.
Key words: Firm life cycle; Corporate risk-taking; Firm performance; Investor
sentiment
JEL classification: D21, G12, G30
doi: 10.1111/acfi.12141
1. Introduction
This study investigates empirically the corporate risk-taking propensities at

different stages of the firm life cycle and the performance consequences of such
risk-taking behaviour. We also examine whether marketwide investor senti-
ment affects risk-taking at different life cycle stages (LCS) differentially.
We thank the Editor Steven Cahan and an anonymous reviewer for many helpful
comments.
Received 7 October 2014; accepted 15 April 2015 by Steven Cahan (Editor in Chief).
© 2015 AFAANZ
2 A. Habib and M. M. Hasan/Accounting and Finance
Corporate risk-taking is the amount of uncertainty associated with expected

outcomes and cash flows, because of new investments (Wright et al., 1996).
Corporate risk-taking has important implications for firm growth, performance
and survival (Bromiley, 1991), but has also been established in the literature as
a serious agency problem (Low, 2009).
Owing to their high concentration of human capital, managers can reduce
their risk at the firm level only, which exposes them to relatively high firm-
specific risk. Therefore, they are likely to exhibit risk-aversion with consequent
significant investment distortions (May, 1995; Parrino et al., 2005). Conserva-
tive risk choices could serve to satisfy a managerial goal of career protection,
among others (John et al., 2008). Conversely, shareholders prefer that firms
undertake any positive net present value (NPV) project, regardless of its
associated risks (Faccio et al., 2011), because of their ability to diversify wealth.
Thus, from an agency perspective, corporate risk-taking can indicate the extent
to which management decisions are aligned with shareholder interests.
An extensive body of literature has investigated the determinants of
corporate risk-taking decisions. Most of this research has concentrated on
explaining risk-taking behaviour from an executive compensation perspective.
Rajgopal and Shevlin (2002) find that employee stock option schemes provide
managers with incentives to invest in risky projects. A positive association
between executive compensation incentives and managerial risk-taking has also
been reported by other studies (e.g. Coles et al., 2006; Armstrong and
Vashishtha, 2012; Shen and Zhang, 2013) although such incentives affect future
performance adversely (Shen and Zhang, 2013).
The existing research on the determinants of corporate risk-taking does not
address adequately the effect of corporate life cycle on risky decision choices of
firms. Corporate life cycle theory proposes that firms pass through a series of
predictable patterns of development and that the resources, capabilities,
strategies, structures and functioning of the firm vary significantly with the
corresponding stages of development (Miller and Friesen, 1980, 1984; Quinn and
Cameron, 1983). Hence, we argue that corporate risk-taking should also respond
to changes in a firm’s LCS. For example, a firm’s resource bases are more fluid and
require more risky investment for expansion during the early phase of the firm’s
life cycle, and increased risk-taking during the decline stage is motivated by the
firm’s desire to return to profitability. Our research responds to Baird and Thomas
(1985, p. 231), who suggest that ‘risk is embedded in most long-range decisions. . .
[and] thus studying the risk-taking propensities of the decision-makers as they
interact with particular decision situations [LCS in this case] will help us better
understand firms’ strategies’. Because managerial risk-taking responds to exec-
utive compensation arrangements, we further argue and test whether variation in
executive compensation during different LCS affects risk-taking differentially.
We then examine whether risk-taking at different LCS has varying
performance implications. Miller and Bromiley (1990) find a significant
negative relationship between income stream and risk-taking (fluctuation of
© 2015 AFAANZ
A. Habib and M. M. Hasan/Accounting and Finance 3
financial ratios such as ROE or ROI). Using stock return risk, Aaker and
Jacobson (1987) find that both systematic and unsystematic risks have a
positive impact on ROI. Bromiley (1991), on the other hand, documented a
negative association between risk-taking and future performance. A negative
association is also reported by Cohen et al. (2013).
We argue, and test empirically, the proposition that risk-taking during
different LCS may explain the inconclusive findings. For example, it is
suggested that investments during the early stage of firm life cycle may not
generate positive returns because of low product differentiation, lack of
efficiency in the production process and shortage of financial resources (Lynall
et al., 2003; Liao, 2006). With an increasing level of product differentiation
during the growth phase, firm profitability starts to increase and peaks during
the mature phase (Dickinson, 2011). However, firm profitability during the
decline stage is again likely to deteriorate, because of negative NPV investments
for firm survival (Benmelech et al., 2010).
Prior research on managerial risk-taking behaviour also confirmed that
managerial risk-taking propensities vary depending on the state of the economy
(Arif and Lee, 2014; McLean and Zhao, 2014). For example, periods with high
growth expectations and easy access to capital are more likely to be
accompanied by excessive risk-taking whilst periods of economic contractions
might result in suboptimal risk-taking (McLean and Zhao, 2014). If markets
are subject to mispricing, and if market signals drive corporate investment
(Dow and Gorton, 1997), then there exists the potential for financial markets to
systematically divert scarce resources to unproductive uses. Firms at different
LCS have different capital requirements, with firms in the early stage requiring
more capital to build up capacity and deter new entry into the market (Spence,
1977, 1979, 1981; Jovanovic, 1982). If external financing is less costly during
periods of high investor sentiment, then managers of early stage firms rationally
‘cater’ to such sentiment by assuming more risk during such periods. As decline
stage firms overinvest in an attempt to return to profitability, firms during this
phase, too, will be catering to marketwide sentiment.
We use a parsimonious life cycle measure proposed by Dickinson (2011) as
our primary independent variable. We use three different measures of risk
widely used in the corporate risk-taking literature, and find that corporate risk-
taking is higher during the introduction and decline stages of the firm life cycle,
whilst lower during the growth and maturity phases of the firm life cycle,
compared to the shake-out stage. We document that future operating
performance is negative for risk-taking during the early and the decline stages
of their life cycles, whilst it is positive for the growth and mature phases. With
respect to the association between risk-taking and investor sentiment, we find
that risk-taking is higher during periods of high investor sentiment. Impor-
tantly, the interaction between life cycle and investor sentiment with respect to
risk-taking reveals that firms in both the early phase and decline phase engage
in more risk-taking during periods of high market sentiment.
© 2015 AFAANZ
We now discuss the results for H3, which attempts to examine the
moderating effect, if any, on the relationship between corporate risk-taking
and life cycle. We investigate the interactive association between firm LCS and
investor sentiment on managerial propensity to take risks. We measure investor
sentiment using the Baker and Wurgler (2006) investor sentiment index. Results
reported in Table 5 show that the coefficient on investor sentiment (SENT) is
positive and statistically significant for the STD_ROA and STD_RET risk
proxies. As SENT is measured as a dummy variable coded 1 for a high investor
sentiment period and zero otherwise, the reported coefficient on SENT for the
STD_ROA risk proxy implies a 3 percent increase in the STD_ROA in periods of
high, compared to low, investor sentiment. The increase in the STD_RET,
however, is much less pronounced. With respect to the interactions, Table 5
reveals that the coefficients for SENT*INTRO and SENT*DECLINE are
positive and significant across all three risk specifications, supporting H3. We also
find that the coefficient SENT*GROWTH is positive and significant, but only for
the STD_RET-based risk proxy (coefficient 0.001, t-statistic 2.63, significant
p < 0.05). The coefficient on the interactive variable SENT*MATURE is
insignificant across all risk specifications, consistent with the proposition that
mature companies do not have future growth opportunities and, hence, find little
benefit in raising capital from the market. Overall, we provide evidence that
managerial risk-taking during different LCS does vary with changes in economy-
wide investor sentiment. It is interesting to note that, although risk-taking during
high sentiment period goes up, there does not appear to be any evidence of less
risk-taking during periods of low investor sentiment.
4.4. Two-stage least squares regression
Even though regression estimates suggest significant negative (positive)

association between growth and maturity (introduction and decline) stages and
corporate risk-taking, the sign, magnitude or statistical significance of these
estimates may be biased due to endogeneity. To address this concern, we adopt a
two-stage instrumental variable approach to re-examine the regression findings
reported in Table 3. Hence, we use industry LCS and firm-level variables as
instruments for firm life cycle proxies (i.e. dividend payment – a dummy variable
that takes a value of 1 if the firm pays dividend in a given year, 0 otherwise, and
organisation capital – measured following Eisfeldt and Papanikolaou, 2013). Use
of industry LCS as instruments can be justified on the premise that industry level
life cycle has a profound effect on the firm-level LCS (Lumpkin and Dess, 2001).
DeAngelo et al. (2006) demonstrate that corporate life cycle has a significant
influence on the probability of dividend payment. They document that mature
and profitable firms are more likely to pay dividends, whilst young firms with
higher growth options are less likely to do so. In a recent study, Hasan and
Cheung (2014) show that introduction and decline stages are likely to be
associated with higher organisational capital. However, firms with a lower level
© 2015 AFAANZ
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© 2015 AFAANZ
investment. The study of Dickinson (2011) also suggests that decline-stage

firms increase their research and development as a turnaround attempt. The
higher risk-taking during the decline stage of the firm life cycle can also be
explained following the hidden action model developed by Benmelech et al.
(2010). They show that when a firm experiences a decline in the growth rate
of investment opportunities, the manager of the firm has an incentive to
invest in projects of negative NPV in order to maintain the pretence that
investment opportunities are still strong. Based on these arguments, we
develop the following hypothesis (we do not develop any directional
prediction regarding risk-taking during growth stage because of the
competing arguments above):
H1: Compared to the shake-out stage of a firm’s life cycle, corporate risk-taking
is higher during the introduction and decline stages of its life cycle but lower
during the maturity stage.2
Agency theory proposes that shareholders prefer that firms undertake any
positive NPV project, regardless of its associated risks, because shareholders
are able to diversify risks (Faccio et al., 2011). As long as managerial interests
are aligned with those with shareholders, corporate risk-taking would yield
positive future benefits. On the other hand, misalignment of interests due to
managerial self-serving behaviour and improperly designed incentives could
affect future performance adversely.
However, the risk-taking and future performance relationship is not uniform
across firms, as different firms pass through different life cycle phases with
observable differences in risk-taking. For example, it is suggested that
investments during the early stage of a firm’s life cycle might yield negative
returns because of low product differentiation, lack of efficiency in the
production process and shortage of financial resources (Lynall et al., 2003;
Liao, 2006). Another potential explanation for negative firm performance
during the early stage of the life cycle is derived from agency theory. Agency
theory arguments propose that during the early phase of the firm life cycle,
managers may invest in diversifying strategies inefficiently, enter into hedging
and insurance relationships, or seek opportunities to increase the longevity of
the company, to the detriment of short-run optimisation (Donaldson and
Lorsch, 1983; Doukas and Kan, 2004). This is exacerbated by a high degree of
information asymmetry between managers and investors.
2
As Dickinson (2011) remarks, the literature clearly spells out the role of different stages
of the firm life cycle except for the shake-out stage. As a result, the expected signs of this
stage are unclear. Thus, in developing hypothesis H1, we use the shake-out stage as a
basis of comparison with other stages of the firm life cycle. In a recent study, Hasan
et al. (2015) also used the shake-out stage in examining the impact of corporate life cycle
on the cost of equity capital.
© 2015 AFAANZ
With respect to profitability during growth phase, it is suggested that as

product differentiation generates higher profit margins (Selling and Stickney,
1989), and growth firms are likely to exert the greatest effort to establish their
brand identity and market share; growth firms benefit most in the future from
current expenditure on product differentiation (Dickinson, 2011). Further-
more, substantial investments during the introduction phase start generating
returns during the growth phase: a positive implication for future profitabil-
ity. In addition, cautious investment strategies during the growth phase are
likely to yield superior future performance (Miller and Friesen, 1984).
Economic theory stipulates that profit margins are maximised with increases
in investment and efficiency (Spence, 1977, 1979, 1981; Wernerfelt, 1985),
which means that profitability should be highest during the growth and
maturity stages. During the decline stage of the firm life cycle, declining
growth leads to declining prices (Wernerfelt, 1985). Additional investments
during the declining phase are justified by a drive for return to profitability.
However, the manager of the firm has an incentive to invest in projects
having negative NPV in order to convince outsiders that investment
opportunities are still strong (Benmelech et al., 2010). Investments in negative
NPV will, therefore, generate poor future performance. We develop the
following hypothesis:
H2: Compared to the shake-out stage of a firm life cycle, future firm performance
will be negatively associated with risk-taking during the early and decline stages
of the life cycle, but positively related to risk-taking during the growth and
maturity stages.
As risk-taking in the form of capital investments requires access to

external capital markets, it is important that the prevalent state of the
economy is given adequate consideration. Stein (1996) argues that if the
required return on a share is reflective of investor sentiment rather than the
share’s underlying risk, then the investment decision will depend on investor
sentiment. Baker and Wurgler (2007, p. 129) define investor sentiment ‘as a
belief about future cash flows and investment risks that is not justified by
the facts at hand’.3 During periods of high investor sentiment, market
mispricing (overvaluation) of equity encourages managers to issue more
3
Recent work in finance has studied the impact of such sentiment on corporate actions,
such as equity issues (Baker and Wurgler, 2002), dividend payouts (Baker and Wurgler,
2004; Li and Lie, 2006), investment (Gilchrist et al., 2005; Polk and Sapienza, 2009) and
acquisitions (Dong et al., 2006). In the financial reporting context, investor sentiment
has been found to have influenced management forecast disclosures (Bergman and
Roychowdhury, 2008), analyst forecast properties (Hribar and McInnis, 2012),
disclosure of pro-forma earnings metrics (Brown et al., 2012), earnings management
(Simpson, 2013) and the sensitivity of stock prices to firm-specific earnings news (Mian
and Sankaraguruswamy, 2012).
© 2015 AFAANZ
equity (Baker and Wurgler, 2000, 2002; Baker et al., 2003). They argue that
overvaluation affects investment decisions through an equity channel (raising
additional equity during periods of high investor sentiment translates into
more investments). The agency hypothesis predicts that high accruals firms
will use (overvalued) equity excessively to pay for mergers and acquisi-
tions and overinvest in property, plant, and equipment (i.e. capital
expenditures) and R&D (Jensen, 2005). Overvaluation of equity during a
high investor sentiment period motivates managers of overpriced firms to
take on negative NPV investment projects (Baker et al., 2003). Similarly,
underpriced firms forego investment projects with positive NPV, that is
market overvaluation (undervaluation) will coincide with higher (lower)
levels of aggregate investment, even though the subsequent returns to these
investments may be lower (higher) than expected (Arif and Lee, 2014).
Either way, investor sentiment and managerial risk-taking should be
positively correlated.
This argument, however, assumes that in equilibrium, all firms that are
overpriced (underpriced) during a high investor sentiment period will assume
more (less) risk. However, as hypothesised in H1 above, corporate risk-taking
varies across the firm LCS and might also respond to prevalent investor
sentiment. Early-stage firms, for example, are more vulnerable to market
misvaluation during periods of both high and low investor sentiment because of
the outcome uncertainty of initial investments: in particular, investments in
R&D along with a poor information environment. The resolution of all
valuation uncertainty, which would necessarily eliminate any mispricing, takes
longer for R&D projects than for other types of projects (Polk and Sapienza,
2009). Hence, firms in the growth phase of their life cycle may demand
additional investment to sustain misvaluation. For mature firms, risk-taking
during periods of high investor sentiment may not differ from that during low-
sentiment periods. By their definition, mature firms have exhausted their
positive NPV projects, meaning they have fewer investment opportunities in
the future. Richardson (2006) suggests that investments of mature firms are
more likely to be geared towards the maintenance of assets in place. The lack of
future growth opportunities minimises the need for additional borrowing
(Barclay and Smith, 2005). Therefore, economy-wide sentiment as an expla-
nation for risk-taking during the mature stage is less of an issue. Decline-stage
firms, in contrast, have incentives to take risks in order to revert to profitability
for survival. Such risk-taking incentives motivate managers to source cheaper
capital, which becomes available during periods of high investor sentiment. We,
therefore, expect risk-taking by decline-stage firms to increase during periods of
high investor sentiment. The following hypothesis is developed.
H3: Risk-taking by firms in the introduction, growth and decline stage of their
LC will be high during periods of high investor sentiment compared to periods of
low investor sentiment.
© 2015 AFAANZ
3. Research design and sample description
3.1. Sample and data
Our sample includes all nonfinancial (excluding SIC 6000–6900) firms on the
Compustat fundamentals annual file that has the required financial information
from 1987 to 2013. Stock price information is acquired from the Centre for
Research in Security Prices (CRSP) database. Our sample period begins in 1987
because, prior to that year, cash-flow data required for estimating the life cycle
are unavailable.4 To avoid the undesirable influence of outliers, we winsorise
the continuous variables at the 1st and 99th percentiles. We exclude
observations with missing values from the measurement of the key dependent
variable (risk-taking proxies), independent variable (life cycle proxy) and
control variables. Table 1 presents the selection (panel A) and industry
distribution (panel B) of the sample. Variable definitions are presented in the
Appendix.
We begin with an initial sample of 299 184 firm-year observations. Exclusion
of financial firms (75 908 firm-years), duplicate observations and firms with
missing values for the variables used in regression model (102 273 firm-years)
yields a final sample size of 121 003 firm-year observations. The number of
observations in any given regression varies from 121 003 to 70 104 firm-years
depending on the model’s specific data requirements. Panel B reports the
composition of the sample by the twelve industry groups. The sample is
distributed across industries unevenly, with the largest number being in the
business equipment (22.48 percent) and other industries (16.25 percent).
3.2. Empirical model
We estimate the following regression model to test the relationship between

firm life cycle and risk-taking (test of H1):
X
4
RISKi;t ¼ a0 þ bj LCSDUMi;t þ b5 SIZEi;t þ b6 MTBi;t þ b7 LEVi;t
j¼1
þbX8 CAPEXi;t þ b9XDSALESi;t þ b10 AGEi;t þ b11 PMi;t
þ t at YEARt þ t at INDt þ ei;t ; ð1Þ
where RISK, corporate risk-taking measures; LCSDUM, a vector of dummy

variables that capture firms’ different stages in the life cycle following the
Dickinson (2011) model wherein b1 to b4 denotes introduction, growth, mature
4
Firms are required to disclose cash-flow data under the Statement of Financial
Accounting Standards No. 95.
© 2015 AFAANZ
Table 1
Sample selection and distribution of the sample
Total number of
Description observations
Panel A: data and sample
Data available in Compustat fundamentals annual file from 1987 to 2013 299 184
Less:
Financial firms (75 908)
223 276
Duplicates in terms of gvkey fyear (92)
223 184
Missing values for cash-flow variables (life cycle proxy) (27 072)
196 112
Firms with missing values for the control variables in regression model (69 547)
126 565
Missing values for dependent variable (STD_ROA) (5562)
Final Sample (firm-years) 121 003
Industry Total number of observations % of observations
Panel B: industry distribution
Business equipment 27 205 22.48

Other 19 663 16.25
Manufacturing 15 327 12.67
Health care, medical equipment, and drugs 14 498 11.98
Wholesale, retail and some services 14 004 11.57
Consumer nondurables 7864 6.50
Oil, gas and coal extraction and products 6531 5.40
Telephone and television transmission 4709 3.89
Utilities 4190 3.46
Chemicals and allied products 3540 2.93
Consumer durables 3472 2.87
Total 121 003 100
This table shows sample selection for regression model 1 (STD_ROA). For regression model 2
(STD_RET) and model 3 (R&D/TA), final sample is 108 153 and 70 104, respectively.
and decline, respectively (this sequence of coefficients of LCS is also applicable

for models 2 and 3 below); SIZE, firm size measured by the natural logarithm
of total assets (AT) of the firm at the end of the fiscal year; MTB, market-to-
book ratio measured as market value of equity (PRCC_F*CSHO) scaled by
book-value of equity (CEQ) at the end of the fiscal year; LEV, leverage
measured by the ratio of total debt (DLTT + DLC) to total equity (CEQ) at
the end of the fiscal year; CAPEX, capital expenditure (CAPX) scaled by
market value of asset (PRCC_F*CSHO + DLTT); ΔSALE, change in sales
(SALE) scaled by lagged sales; AGE, age is measured as the number of years
since the firm was first covered by the Centre for Research in Securities Prices
© 2015 AFAANZ
(CRSP) (DATADATE – BEGDAT). For regression analysis, we measure AGE

as natural log of (1+ age of the firm); PM, profit margin, measured as income
before tax and extraordinary items (PI – XI) scaled by sales (SALE); Year,
dummy variables to control for year effect; IND, dummy variables to control
for industry effect.
Our main variable of interest is LCSi,t in the empirical model. We predict bj
to be positive for the introduction and decline stages but negative for the
growth and mature stage of the life cycle, compared to the shake-out stage.
To test H2, that is the association between risk-taking and future perfor-
mance conditional on firm LCS, we estimate the following regression
specification:
X
4 X
9
ROAi;tþ1 ¼ a0 þ bj LCSDUMi;t þ b5 RISKi;t þ bk RISKi;t
j¼1 k¼6
LCSDUMk;i;t þ b10 SIZE þ b11 MTBi;t þ b12 LEVi;t
þbX13 CAPEXi;t þ bX14 DSALESi;t þ b15 AGEi;t þ b16 PMi;t
þ t at YEARt þ t at INDt þ ei;t : ð2Þ
Our dependent variable is 1-year-ahead ROA, a proxy for firm profitability.

Our variable of primary interest is the interaction variables RISK*LCSDUM.
We expect the coefficient to be negative for firms in the introduction and decline
stage of their life cycle, whilst positive and significant for the growth and
mature stages.
Finally to test H3, that is the moderating effect of investor sentiment on the
association between risk-taking and firm LCS, we develop the following
regression specification:
X
4
RISKi;t ¼ a0 þ bj LCSDUMi;t þ b5 SENTi;t
j¼1
X
9
þ bk SENTi;t LCSDUMk;i;t SENTi;t þ b10 SIZEi;t
k¼6
þ b11 MTBi;t þ b12 LEVi;t þ b13 CAPEXi;t þ b14 DSALESi;t
X X
þ b15 AGEi;t þ b16 PMi;t þ t at YEARt þ t at INDt þ ei;t : ð3Þ
We interact an investor sentiment proxy with firm LCS to evaluate the

incremental effect of investor sentiment on the life cycle and risk-taking
relationship. We expect the coefficient b5 to be significantly positive, supporting
the notion that corporate risk-taking increases during periods of high investor
sentiment. Investor sentiment is based on the common variation in six
© 2015 AFAANZ
underlying proxies for sentiment: the closed-end fund discount, NYSE share
turnover, the number and average of first-day returns on IPOs, the equity share
in new issues, and the dividend premium (Baker and Wurgler, 2006). As each
sentiment proxy is likely to include a sentiment component as well as
idiosyncratic components, the authors use principal components analysis to
isolate the common component. Investor sentiment, SENT, is an indicator
variable coded 1 for a high sentiment period (SENT index greater than zero)
and zero otherwise. This procedure yields 1987–88, 1996–97, 1999–01, 2004 and
2006–07 as high sentiment periods. We expect the coefficients on the interactive
variable SENT*LCS to be positive for the introduction, growth and decline
stages of a firm’s life cycle compared to the shake-out stage.
3.3. Explanatory variables: estimation of firm life cycle proxies
Assessing the LCS at the firm level is difficult because the individual firm is
composed of many overlapping, but distinct, product LCS. Moreover, firms
can compete in multiple industries, and their product offerings are fairly diverse
(Dickinson, 2011). To overcome this estimation problem, we follow the
methodologies of Dickinson (2011) in order to develop proxies for the firms’
stage in the life cycle.5 Dickinson (2011) relies on the economics literature in
addressing the individual attributes of life cycle theory, such as production
behaviour (Spence, 1977, 1979, 1981; Wernerfelt, 1985; Jovanovic and
MacDonald, 1994), learning/experience (Spence, 1981), investment (Spence,
1977, 1979; Jovanovic, 1982; Wernerfelt, 1985), entry/exit patterns (Caves,
1998) and market share (Wernerfelt, 1985). Using these attributes, she develops
a parsimonious firm-level life cycle proxy based on the predicted behaviour of
operating, investing and financing cash flows across different LCS, which are
the result of firm performance and the allocation of resources. She argues that
cash flows capture differences in a firm’s profitability, growth and risk and,
hence, that one may use the cash flow from operating (OCF), investing
(INVCF) and financing (FINCF) to group firms in LCS, such as ‘introduction’,
‘growth’, ‘mature’, ‘shake-out’ and ‘decline’.
The methodology is based on the following cash-flow pattern classification:
(1) Introduction: if OCF < 0, INVCF < 0 and FINCF ˃ 0;
5
Anthony and Ramesh (1992) provide one of the first empirical procedures for
classifying firms in different LCS. However, we do not use their method for three
reasons. These include (1) The life cycle classification based on Anthony and Ramesh
(1992) requires a five year history of variables, removing true ‘introduction stage’ firms
from the sample. Thus, no data (and as such, no meaningful analysis) on introduction
stage firms are available. (2) Dickinson (2011) has shown that life cycle classification
based on the Anthony and Ramesh (1992) procedure leads to an erronous classification
of the stage of firms in the life cycle. (3) This classification procedure is ‘ad hoc’ and
relies on portfolio sorts to classify the firm into different LCS.
© 2015 AFAANZ
(2) Growth: if OCF ˃ 0, INVCF < 0 and FINCF ˃ 0;

(3) Mature: if OCF ˃ 0, INVCF < 0 and FINCF < 0;
(4) Decline: if OCF < 0, INVCF ˃ 0 and FINCF ≤ or ≥ 0; and
(5) Shake-out: the remaining firm-years will be classified under the shake-out
stage.
3.4 Dependent variable: estimation of firm risk-taking
Motivated by prior literature, we employ three measures of corporate risk-

taking in our empirical analysis. Our first measure of corporate risk-taking,
the standard deviation of return on assets (STD_ROA), captures the overall
risk taken by the firm (Li et al., 2013). We measure standard deviation of the
income before tax and extraordinary items, scaled by total assets, over the
prior 3 years. Prior research (e.g. John et al., 2008; Zhang, 2009) shows that
riskier corporate operations lead to more volatile earnings and, hence,
STD_ROA is extensively used as a firm risk-taking proxy in the risk-taking
literature. Our second measure of corporate risk-taking, the standard
deviation of returns (STD_RET), captures a firm’s equity risk and the
consequences of changing investment strategies (Bargeron et al., 2010). We
measure STD_RET as the annual standard deviation of monthly stock
returns, computed from return data from the CRSP. High values of
STD_RET denote more dispersion and, thus, high levels of risk (Markowitz,
1952; Bargeron et al., 2010). Finally, we use R&D expenditure scaled by assets
(R&D/TA) as a proxy for firm risk-taking. Following prior research, we set
R&D equal to zero when it is missing from Compustat. Prior studies suggest
that R&D expenditures are a high-risk investment (Bhagat and Welch, 1995)
as they have a low likelihood of success and their future pay-off is distant and
uncertain (Li et al., 2013). Thus, this measure captures firm risk-taking in
long-term corporate investment effectively.
3.5. Control variables
Prior studies suggest that managerial investment behaviour is impacted by

internal factors (e.g. firms’ financial resources, performance and growth) and
the external environment (e.g. industry competitiveness and economic factors).
Hence, the above regressions control for a number of variables that prior
studies have found to be associated with corporate risk-taking (e.g. John et al.,
2008; Faccio et al., 2011). Firm size (SIZE) is related to risk-taking negatively,
as smaller firms are more aggressive and involved in more risky investment
compared to larger firms (Perez-Quiros and Timmermann, 2000; Bargeron
et al., 2010). Firms with high growth opportunities (GROWTH measured as
the ratio of market value of equity to book-value of equity) are likely to take
more risky investments and, hence, should be related to risk-taking positively.
© 2015 AFAANZ
Li et al. (2013) show that firm-level leverage is negatively associated with

corporate risk-taking, because leverage may constrain investment and corpo-
rate risk. Therefore, we control for firm-level leverage (LEV), measured as total
debt scaled by total assets. Sales growth reflects firms’ operating performance
relative to the previous year. Studies (e.g. Anthony and Ramesh, 1992) show
that investment is less rewarding when sales growth is slow. Thus, to capture
the influence of firm-specific sales growth on corporate risk-taking, we control
for firm sales growth. As higher levels of risk generally relate to larger returns,
we control for the firm’s current profitability by including profit margin (PM),
measured as the income before tax and extraordinary items, scaled by sales.
Prior studies suggest that a firm’s capital expenditures are associated with
corporate risk-taking (Coles et al., 2006). We measure capital expenditures
(CAPEX), as capital expenditures scaled by market value of equity. Younger
firms have more incentive to engage in risky investments, whilst older and more
diversified firms exhibit less variability in performance (Adams et al., 2005). We
control for this effect by including age (AGE), measured as the log of the
number of years since the firm’s first appearance in the CRSP database. Finally,
to control for unobservable industry and year characteristics associated with
firm risk-taking and LCS, we include year and industry dummy variables in all
our regression specifications.
To take into account the time series and cross-sectional dependence in the
error terms of our regressions, we calculate t-statistics using standard errors
that are clustered by both firm and year (Petersen, 2009; Gow et al., 2010).
4. Empirical results
4.1. Descriptive statistics
Table 2 presents descriptive statistics for the variables included in the

regression estimates. Panel A reports pooled descriptive statistics for the
dependent, independent and control variables, and Panel B presents the
Pearson’s correlations. Panel A reveals that the mean (median) STD_ROA,
STD_RET and R&D_TA are 0.153 (0.052), 0.041 (0.034) and 0.102 (0.040),
respectively. These statistics are largely within the range of prior studies (e.g.
Bargeron et al., 2010; Table 1). The mean values of SIZE (5.04), MTB (2.66),
DSALE (0.22) and AGE (15.82) in Panel A also suggest the presence of growth
and mature firms in the sample.
The life cycle-wise descriptive statistics reveal that the mean STD_ROA,
STD_RET and R&D_TA are higher in the introduction (0.36, 0.06 and 0.19),
shake-out (0.15, 0.05 and 0.09) and decline (0.30, 0.06 and 0.24) stages
compared to the growth (0.09, 0.04 and 0.06) and mature (0.08, 0.03 and 0.05)
stages of the firm life cycle. Consistent with the firm life cycle theory, our
statistics also reveal that SIZE, AGE and PM progressively increase as firms
move from the introduction to the mature stages and that these estimates then
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Table 2
Descriptive statistics and correlation analysis
Panel A: pooled descriptive statistics
Variable n Mean SD 0.25 0.50 0.75 INTRO GROWTH MATURE SHAKE-OUT DECLINE
© 2015 AFAANZ
STD_ROA 121 003 0.153 0.391 0.023 0.052 0.128 0.359 0.087 0.079 0.150 0.302
STD_RET 108 153 0.041 0.027 0.022 0.034 0.051 0.058 0.035 0.033 0.047 0.062
R&D/TA 70 104 0.102 0.180 0.006 0.040 0.120 0.190 0.060 0.046 0.094 0.242
SIZE 121 003 5.043 2.491 3.258 5.009 6.802 3.682 5.710 5.671 4.369 3.449
MTB 121 003 2.655 5.443 0.978 1.763 3.194 3.347 2.777 2.422 2.060 2.605
LEV 121 003 0.185 0.215 0.003 0.122 0.294 0.182 0.214 0.181 0.160 0.143
CAPEX 121 003 0.064 0.090 0.014 0.035 0.077 0.056 0.086 0.060 0.051 0.042
DSALE 121 003 0.218 0.831 0.041 0.078 0.240 0.480 0.286 0.094 0.080 0.193
AGE 121 003 15.82 15.26 5.20 11.01 21.13 10.225 14.990 19.733 16.338 11.451
PM 121 003 0.764 4.582 0.086 0.034 0.103 2.862 0.016 0.047 0.418 3.297
SENT__D 113 620 0.465 0.499 0.000 0.000 1.000 – – – – –
Panel B: correlation analysis
Variable INTRO GROWTH MATURE SHAKE-OUT DECLINE
STD_ROA 0.235 0.105 0.147 0.003 0.114

STD_RET 0.264 0.140 0.232 0.066 0.228
R&D/TA 0.239 0.137 0.228 0.016 0.261
SIZE 0.244 0.167 0.196 0.089 0.191
A. Habib and M. M. Hasan/Accounting and Finance
MTB 0.057 0.014 0.033 0.036 0.003

LEV 0.007 0.082 0.014 0.039 0.058
CAPEX 0.041 0.151 0.037 0.050 0.073
DSALE 0.141 0.051 0.117 0.051 0.010
AGE 0.164 0.034 0.199 0.011 0.086
PM 0.204 0.106 0.137 0.025 0.165
15
All variables, except those in italics, are significant at p < 0.001.

drop as firms move from the mature to the decline stage; the opposite pattern is
observed for the MTB and DSALE variables.
In Table 2, panel B reveals that firm risk-taking proxies and most of the
control variables are correlated significantly with life cycle proxies. As
expected, all the three risk-taking proxies are associated positively
(p < 0.001) with the introduction and decline stages of the firm life cycle,
whilst being associated negatively (p < 0.001) with the growth and mature
stages of the firm life cycle. Overall, the correlations among risk-taking proxies,
life cycle proxies and the control variables are all in the expected directions and,
thus, provide support for our measures and constructs.
4.2. Regression results
In Table 3, panel A presents the regression results for Equation (1) where
risk-taking proxies are regressed on firm LCS and a set of control variables
known to determine risk-taking decisions. The regression results provide strong
evidence that risk-taking is high during the introduction and decline stages of
the firm cycle whilst it is low during the growth and mature stages of the life
cycle across all risk proxies, supporting H1. For example, the coefficients on
STD_RET, a risk-taking proxy, range from 0.005 during the growth and
mature stages to 0.007 during the decline stage of the firm life cycle.
As hypothesised in Section 2, a firm is more likely to undertake relatively
larger, growth-oriented investments in the initial stage, whilst, in the mature
stage, its investments are more likely to be geared towards maintenance of
assets in place. Once a firm moves into the decline phase, managers are likely to
assume more risk in an attempt to return to profitability, as declining sales
during this phase generate negative returns. The negative coefficient during the
growth phase may be explained by an observation of Miller and Friesen (1984),
who suggest that complex product strategies during the growth phase require
more managerial involvement in decision-making and, hence, there is less risk-
taking.
We also include a proxy for firm strategy (STRATEGY) to incorporate the
notion that variation in firms’ strategies (for example, prospector versus
defender-type business strategies) (Miles and Snow, 1978, Miles and Snow
2003) during different life cycle phases might differentially affect risk-taking
behaviour. Our composite strategy score is derived from Bentley et al. (2013).
Bentley et al. (2013) constructed their index using a wide variety of firm
characteristics intended to capture the differences in the magnitude and
direction of change regarding its products and markets (Hambrick, 1983). We
find the coefficient on STRATEGY to be positive and statistically significant
across all three risk proxies. Importantly, the coefficients on the LCS remain
qualitatively unchanged. We also run the baseline regression model including
CEO age (a proxy for CEO career concern) as a determinant of corporate risk-
taking. Serfling (2014) documents that risk-taking by CEOs decreases with an
© 2015 AFAANZ
Table 3
Regression results
4
X
RISKi;t ¼ a0 þ bj LCSDUMi;t þ b5 SIZEi;t þ b6 MTBi;t þ b7 LEVi;t þ b8 CAPEXi;t þ b9 DSALESi;t þ b10 AGEi;t þ b11 PMi;t
j¼1 ð1Þ
X X
þ t at YEARt þ t at INDt þ ei;t
© 2015 AFAANZ
With ‘STRATEGY’ included
Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
Variables Predicted sign STD_ROA STD_RET R&D/TA STD_ROA STD_RET R&D/TA
Panel A: firm life cycle and corporate risk-taking
Constant ? 0.17*** 0.07*** 0.08*** 0.06*** 0.06*** 0.03

[8.14] [30.64] [4.86] [5.60] [23.00] [1.57]
INTRO + 0.12*** 0.004*** 0.048*** 0.04*** 0.004*** 0.03***
[17.07] [11.50] [13.90] [9.98] [9.65] [9.39]
GROWTH +/ 0.01*** 0.005*** 0.009*** 0.01*** 0.003*** 0.006***
[3.44] [16.45] [4.54] [6.12] [9.39] [3.89]
MATURE – 0.01*** 0.005*** 0.01*** 0.01*** 0.003*** 0.007***
[3.98] [16.98] [7.36] [7.93] [9.89] [5.20]
DECLINE + 0.05*** 0.007*** 0.09*** 0.04*** 0.006*** 0.05***
[7.65] [17.89] [20.62] [9.44] [11.67] [11.72]
SIZE – 0.03*** 0.006*** 0.009*** 0.01*** 0.005*** 0.004***
[25.93] [85.07] [13.99] [24.76] [63.73] [9.42]

MTB + 0.0006* 0.000*** 0.0006*** 0.002*** 0.0002*** 0.001***
[1.66] [13.30] [2.74] [6.46] [10.67] [3.81]
LEV 0.05*** 0.001*** 0.004 0.00 0.005*** 0.03***
[3.66] [2.66] [0.50] [0.15] [6.09] [5.85]
(continued)
17
18
Table 3 (Continued)
With ‘STRATEGY’ included
Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
© 2015 AFAANZ
Variables Predicted sign STD_ROA STD_RET R&D/TA STD_ROA STD_RET R&D/TA
CAPEX + 0.008 0.011*** 0.16*** 0.00* 0.01*** 0.16

[0.35] [8.09] [7.78] [1.88] [5.88] [10.57]
ΔSALES + 0.05*** 0.001*** 0.002** 0.02*** 0.00 0.008***
[16.26] [6.33] [2.40] [5.50] [0.15] [4.27]
AGE 0.002* –0.002*** 0.000 –0.009*** –0.003*** –0.006***
[1.72] [15.16] [0.29] [5.23] [13.41] [4.65]
PM + (?) 0.02*** 0.000*** 0.007*** 0.01*** 0.0005*** 0.007***
[15.16] [12.07] [18.48] [5.15] [7.36] [7.12]
STRATEGY + 0.004*** 0.0005*** 0.006***
[15.72] [16.49] [25.60]
Year Yes Yes Yes Yes Yes Yes
Industry Yes Yes Yes Yes Yes Yes
Observations 121 003 108 153 70 104 68 038 67 609 41 912
Adj. R2 0.19 0.50 0.33 0.15 0.48 0.34
Panel B: firm life cycle, executive compensation and risk-taking

INTRO + 0.03*** 0.006*** 0.03*** 0.03*** 0.004*** 0.02***

[5.21] [12.45] [6.02] [3.61] [3.34] [4.45]
GROWTH +/ 0.02*** 0.002*** 0.011*** 0.02*** 0.003*** 0.009***
[6.75] [5.96] [5.79] [5.48] [3.99] [3.39]
MATURE 0.019*** 0.003*** 0.017*** 0.02*** 0.003*** 0.014***
(continued)
Table 3 (continued)
[7.79] [12.74] [9.26] [6.71] [5.21] [6.01]

DECLINE + 0.08*** 0.009*** 0.07*** 0.09*** 0.009*** 0.07***
© 2015 AFAANZ
[7.78] [13.57] [10.43] [6.45] [5.28] [7.73]
COMP + 0.0008*** 0.003*** 0.001** 0.00 0.0001* 0.002***
[3.60] [4.86] [5.56] [0.43] [1.89] [3.23]
COMP*INTRO + – – – 0.002** 0.004** 0.002**
[2.16] [2.59] [2.60]
COMP*GROWTH + – – – 0.019** 0.0002** 0.024
[2.12] [2.04] [1.09]
COMP*MATURE ? – – – 0.001** 0.00 002 0.00
[2.42] [0.21] [0.55]
COMP*DECLINE ? – – – 0.04 0.00 001 0.001
[0.96] [0.04] [1.32]
Other controls Yes Yes Yes Yes Yes Yes
Year Yes Yes Yes Yes Yes Yes
Industry Yes Yes Yes Yes Yes Yes
Observations 32 425 32 091 19 122 32 425 32 091 19 122
Adj. R2 0.14 0.53 0.39 0.14 0.54 0.39
In the regression models in Panel A, the indicator for the shake-out stage is omitted, and thus, the intercept term captures the effect of the shake-
out stage. Other life cycle stage coefficients are compared relative to the shake-out stage. In panel B, compensation (COMP) is measured as the
natural logarithm of Black–Scholes option value ($) retrieved from EXECUCOMP for the period 1992 to 2013. Robust t-statistics in brackets:
***p < 0.01, **p < 0.05, *p < 0.10.

19
increase in their age primarily because of less risky investment policies. We also
find similar evidence as the coefficient on natural log of CEO age is 0.005 with
a t-statistic of 9.23. Importantly, however, the sign and significance on the
coefficient of LCS remains consistent with the baseline result. Control variables
are generally consistent in terms of their significance and predicted direction.
For example, large firms assume less risk, but firms with high growth
opportunities take on more risk. The adjusted R2 of the risk proxies varies from
a high of 0.50 for the STD_RET proxy to a low of 0.19 for the R&D/TA proxy.
Table 3, panel B examines whether variation in managerial incentives as
proxied by incentive-based compensation during different LCS, differentially
affects risk-taking. Agency theory proposes that a properly designed executive
compensation scheme can motivate managers to mitigate investment distor-
tions (Jensen and Meckling, 1976). However, a similar arrangement could
encourage managers to engage in more risk-taking to maximise personal
benefits. Although prior research has examined the association between
compensation and risk-taking, these studies did not investigate the role of
organisational evolution in the compensation–risk-taking relationship. The
organisation will use different compensation systems at each LCS to motivate
and reward its CEO to make effective decisions. This is very important as
resolving these challenges and problems successfully allows the organisation to
transition from one stage to another (Scott and Bruce, 1987; Phelps et al.,
2007). Despite this theoretical underpinning, empirical evidence on the
association between the mix and structure of executive compensation during
different LCS is almost nonexistent (Kanagaretnam et al., 2009; is an
exception). On the other hand, a growing literature confirms that incentive-
based compensation encourages managers to take more risks (e.g. Coles et al.,
2006; Armstrong and Vashishtha, 2012; Shen and Zhang, 2013). However,
these two strands of literature remain disconnected.
We measure compensation using the natural log of incentive-based
compensation retrieved from Execucomp. The sample period spans from
1992 to 2013. Models (1) to (3) show that the coefficient on compensation
(COMP) is reliably positive and significant, implying that more incentive-
based compensation encourages managers to assume more risk. Our main
interest is the sign and significance of the interactive variables (COMP*LCS).
Models (4) to (6) present the results. We find that the coefficient on the
interactive variable COMP*INTRO is positive and significant across all three
risk specifications. Because start-up firms are characterised as having a low
level of product diversification and of production innovation, they may offer
CEOs a large amount of stock-based pay to align the interests of shareholders
in terms of motivating CEOs to expand product diversification and
innovation (Wang and Sing, 2014). We also expect firms in the growth phase
to award executives with long-term incentive pay to mitigate potential agency
conflicts associated with the increased difficulties in monitoring CEO’s
investment behaviour (Mehran and Tracy, 2001). Our reported results show
© 2015 AFAANZ
that the coefficient on COMP*GROWTH is positive and significant for two

of the three risk proxies (STD_ROA and STD_RET). Firms in the maturity
phase of their life cycle strive to avoid risk to maintain the stability of their
business operations (Lester et al., 2008), which does not require them to
award stock-based pay to CEOs for making risky decisions. The insignificant
coefficient on COMP*MATURE supports this proposition. We do not
develop a directional hypothesis for COMP*DECLINE, as there is a lack of
theory as to the structure of incentive-based compensation for firms in the
decline stage, although Kanagaretnam et al. (2009) find that growing firms
grant more stock options to their CEOs than do stagnant firms. Taken
together, our analysis of the effect of variation in executive compensation
across firm LCS affect managerial risk-taking propensities differently.
We now discuss the results of Equation (2), which examines the effect of
risk-taking during different LCS on future operating performance. We regress
1-year-ahead ROA on current-period risk proxies and the interaction between
risk proxies and LCS. Results reported in Table 4 show that corporate risk-
taking is negatively related to future performance across all three risk
specifications. We are primarily interested in the interaction between LCS and
risk-taking to discern the performance implications. We reveal that future
performance worsens for risk-taking during the early phase (introduction)
and decline phase of the firm LCS compared to the shake-out stage
(coefficients on RISK*INTRO and RISK*DECLINE are 0.18 and 0.12,
both significant at p < 0.05 for the STD_ROA risk proxy). This is consistent
with the argument that low product differentiation and shortage of financial
resources yield negative profit in the early stage, whilst in the decline stage,
negative profit is explained by managerial incentives to invest in negative
NPV projects.
We find that the coefficient for the interaction RISK*GROWTH is positive
and significant across all three specifications, as is the coefficient on
RISK*MATURE (the respective coefficients are 0.12 and 0.18 significant at
p < 0.01 for the STD_ROA risk proxy). This is consistent with economic
theory, which postulates that profit margins are maximised by increases in
investment and efficiency (Spence, 1977, 1979, 1981; Wernerfelt, 1985). As
product differentiation generates higher profit margins, and growth firms
expand by establishing brand identity and market share, growth firms generate
a positive return (Dickinson, 2011).
Among the control variables, firm profitability is higher for larger firms
(which are also older) because of scale economies or the ability to access capital
at lower costs than smaller firms. Financial risk proxied by leverage is
negatively related to future profitability because of the potential distress costs.
Growth opportunities should affect firm performance positively, although the
reported evidence is not consistent across the risk specifications. Capital
expenditure (CAPEX) increases the denominator of ROA; hence, a negative
relationship with future ROA is reported.
© 2015 AFAANZ
Table 4
LCS, risk-taking and future performance
X
4 X
9
ROAi;tþ1 ¼ a0 þ bj LCSDUMi;t þ b5 RISKi;t þ bk RISKi;t LCSDUMk;i;t
j¼1 k¼6
ð2Þ
þ b10 SIZE þ b11 MTBi;t þ b12 LEVi;t þ b13 CAPEXi;t þ b14 DSALESi;t
X X
þ b15 AGEi;t þ b16 PMi;t þ t at YEARt þ t at INDt þ ei;t
Model (1) Model (2) Model (3)

STD_ROA STD_RET R&D_TA
Variables Predicted sign ROAt+1 ROAt+1 ROAt+1
Constant 0.05*** 0.06*** 0.06*

[3.15] [2.90] [1.68]
INTRO 0.17*** 0.15*** 0.14***
[21.63] [20.44] [14.15]
GROWTH + 0.02*** 0.03*** 0.04***
[4.57] [8.02] [6.13]
MATURE + 0.04*** 0.05*** 0.04***
[8.37] [11.36] [6.09]
DECLINE 0.17*** 0.19*** 0.16***
[17.09] [17.28] [12.49]
RISK 0.25*** 0.21*** 0.64***
[6.88] [4.64] [9.17]
RISK*INTRO 0.18*** 0.06* 0.33***
[4.39] [1.69] [3.98]
RISK*GROWTH + 0.12*** 0.13*** 0.31***
[2.88] [3.64] [3.79]
RISK*MATURE + 0.13*** 0.16*** 0.48***
[2.74] [4.22] [6.25]
RISK*DECLINE 0.12** 0.06*** 0.09**
[2.56] [3.55] [2.08]
SIZE + 0.03*** 0.02*** 0.03***
[43.80] [32.10] [26.03]
MTB +/ 0.001*** 0.00* 0.00
[2.80] [1.74] [0.21]
LEV 0.12*** 0.07*** 0.11***
[11.38] [6.77] [7.58]
CAPEX 0.08*** 0.20*** 0.24***
[3.88] [8.44] [6.46]
ΔSALES ? 0.009*** 0.016*** 0.03***
[2.85] [5.34] [9.15]
AGE + 0.007*** 0.01*** 0.01***
[7.61] [6.79] [5.39]
PM + 0.02*** 0.02*** 0.02***
[26.30] [19.50] [17.26]
Year Yes Yes Yes
Industry Yes Yes Yes
Observations 104 501 95 391 60 956
Adjusted R2 0.34 0.30 0.36
In the regression models, the indicator for the shake-out stage is omitted and, thus, the
intercept term captures the effect of the shake-out stage. Other life cycle stage coefficients are
compared relative to the shake-out stage. Robust t-statistics in brackets: ***p < 0.01,
**p < 0.05, *p < 0.10.
© 2015 AFAANZ
We now discuss the results for H3, which attempts to examine the
moderating effect, if any, on the relationship between corporate risk-taking
and life cycle. We investigate the interactive association between firm LCS and
investor sentiment on managerial propensity to take risks. We measure investor
sentiment using the Baker and Wurgler (2006) investor sentiment index. Results
reported in Table 5 show that the coefficient on investor sentiment (SENT) is
positive and statistically significant for the STD_ROA and STD_RET risk
proxies. As SENT is measured as a dummy variable coded 1 for a high investor
sentiment period and zero otherwise, the reported coefficient on SENT for the
STD_ROA risk proxy implies a 3 percent increase in the STD_ROA in periods of
high, compared to low, investor sentiment. The increase in the STD_RET,
however, is much less pronounced. With respect to the interactions, Table 5
reveals that the coefficients for SENT*INTRO and SENT*DECLINE are
positive and significant across all three risk specifications, supporting H3. We also
find that the coefficient SENT*GROWTH is positive and significant, but only for
the STD_RET-based risk proxy (coefficient 0.001, t-statistic 2.63, significant
p < 0.05). The coefficient on the interactive variable SENT*MATURE is
insignificant across all risk specifications, consistent with the proposition that
mature companies do not have future growth opportunities and, hence, find little
benefit in raising capital from the market. Overall, we provide evidence that
managerial risk-taking during different LCS does vary with changes in economy-
wide investor sentiment. It is interesting to note that, although risk-taking during
high sentiment period goes up, there does not appear to be any evidence of less
risk-taking during periods of low investor sentiment.
4.4. Two-stage least squares regression
Even though regression estimates suggest significant negative (positive)

association between growth and maturity (introduction and decline) stages and
corporate risk-taking, the sign, magnitude or statistical significance of these
estimates may be biased due to endogeneity. To address this concern, we adopt a
two-stage instrumental variable approach to re-examine the regression findings
reported in Table 3. Hence, we use industry LCS and firm-level variables as
instruments for firm life cycle proxies (i.e. dividend payment – a dummy variable
that takes a value of 1 if the firm pays dividend in a given year, 0 otherwise, and
organisation capital – measured following Eisfeldt and Papanikolaou, 2013). Use
of industry LCS as instruments can be justified on the premise that industry level
life cycle has a profound effect on the firm-level LCS (Lumpkin and Dess, 2001).
DeAngelo et al. (2006) demonstrate that corporate life cycle has a significant
influence on the probability of dividend payment. They document that mature
and profitable firms are more likely to pay dividends, whilst young firms with
higher growth options are less likely to do so. In a recent study, Hasan and
Cheung (2014) show that introduction and decline stages are likely to be
associated with higher organisational capital. However, firms with a lower level
© 2015 AFAANZ
Table 5
Life cycle stages, investor sentiment and risk-taking
X
4 X
9
RISKi;t ¼ a0 þ bj LCSDUMi;t þ b5 SENTi;t þ bk SENTi;t LCSDUMk;i;t
j¼1 k¼6
ð3Þ
þ b10 SIZEi;t þ b11 MTBi;t þ b12 LEVi;t þ b13 CAPEXi;t þ b14 DSALESi;t
X X
þ b15 AGEi;t þ b16 PMi;t þ t at YEARt þ t at INDt þ ei;t
Model (1) Model (2) Model (3)

Variables Predicted sign STD_ROA STD_RET R&D_TA
Intercept ? 0.27*** 0.07*** 0.12***

[16.44] [58.12] [15.18]
INTRO + 0.05*** 0.003*** 0.02***
[8.27] [7.27] [11.02]
GROWTH +/ 0.04*** 0.006*** 0.002**
[12.15] [19.92] [2.09]
MATURE 0.03*** 0.006*** 0.01***
[11.24] [18.60] [8.03]
DECLINE + 0.06*** 0.0084*** 0.06***
[8.19] [18.51] [17.22]
SENT + 0.03*** 0.006*** 0.001
[2.92] [13.61] [0.48]
SENT*INTRO + 0.02*** 0.006 *** 0.012***
[3.14] [10.93] [4.45]
SENT*GROWTH + 0.004 0.001*** 0.003*
[0.82] [2.63] [1.70]
SENT*MATURE ? 0.005 0.003 0.003
[1.27] [0.59] [1.58]
SENT*DECLINE + 0.02** 0.003*** 0.018***
[2.25] [4.00] [4.19]
Other controls Yes Yes Yes
Year Yes Yes Yes
Industry Yes Yes Yes
Observations 108 378 98 795 69 807
Adjusted R2 0.38 0.42 0.25
Investor sentiment, SENT, is an indicator variable coded 1 for high sentiment period (SENT
index greater than zero) and zero otherwise. This procedure yields 1987–88, 1996–97, 1999–
01, 2004 and 2006–07 as high sentiment periods. In the regression models, the indicator for
the shake-out stage is omitted, and thus, the intercept term captures the effect of the shake-
out stage. Other life cycle stage coefficients are compared relative to the shake-out stage.
Robust t-statistics in brackets: ***p < 0.01, **p < 0.05, *p < 0.10.
of organisational capital are more likely to be in the growth and mature stages.
These studies, thus, provide justification for the use of dividend and
organisational capital as instruments.
Table 6, panel A reports that coefficients on the instrumental variables are
significant at the conventional level, suggesting that industry life cycle and
© 2015 AFAANZ
Table 6
Two-stage least squares (2SLS) regression
Explanatory variable Introduction Growth Maturity Decline
Panel A: first-stage regressions of life cycle proxies and validity of instruments
Instruments
ILC – introduction 0.654*** 0.040 0.234*** 0.068**
(17.80) (0.79) (4.23) (2.53)
ILC – growth 0.034 0.854*** 0.073 0.032
(1.01) (17.59) (1.36) (1.31)
ILC – maturity 0.049 0.004 1.052*** 0.016
(1.45) (0.10) (19.37) (0.64)
ILC – decline 0.059 0.103 0.121 0.694***
(1.14) (1.47) (1.57) (16.81)
Dividend 0.046*** 0.113** 0.190*** 0.0229***
(20.18) (29.60) (44.70) (13.98)
Organisation capital 0.000 0.000*** 0.000 0.000
(0.32) (3.09) (0.21) (1.27)
Unreported control variables included in regression
All variables in main test Yes Yes Yes Yes
Year FE Yes Yes Yes Yes
Industry FE Yes Yes Yes Yes
Observations 87 703 87 703 87 703 87 703
Adjusted R2 0.133 0.111 0.145 0.060
Underidentification test
Kleibergen–Paap rk LM 360.06
statistic
p-Value 0.000
Weak identification test
Corrected Cragg–Donald 185.05
Wald F-statistic
Stock and Yogo (2005) 29.18
10% maximal IV size
(critical value)
Test of overidentifying restrictions
Hansen’s J-statistic 3.69
p-Value 0.16
Panel B: second-stage regressions of corporate risk-taking on life cycle proxy
Explanatory variable
Potentially endogenous instrumented variable
Life cycle proxy 0.068** 0.083*** 0.036* 0.488***
(2.24) (3.46) (1.65) (9.36)
All variables in main test Yes Yes Yes Yes
Year dummies Yes Yes Yes Yes
Industry dummies Yes Yes Yes Yes
Hausman test for the effect of life cycle (coefficient 2SLS = coefficient OLS)
Cluster-robust F-statistic 519.62
p-value 0.000
Results for two-stage analysis as described in Section 4.4. ILC stands for industry life cycle.
Robust t-statistics in brackets: ***p < 0.01, **p < 0.05, *p < 0.10.
© 2015 AFAANZ
included firm-level variable have a significant effect on firm LCS. Results in

Table 6, panel B, suggest that the relationship between life cycle proxies and
corporate risk-taking remains robust after accounting for the endogenous
relationship between the life cycle proxies and the risk-taking. The estimated
coefficients (and p-values) of introduction (0.069, p < 0.05), growth (0.083,
p < 0.01), mature (0.036, p < 0.10), decline (0.488, p < 0.01) in the two-stage
least squares (2SLS) regression suggest that endogeneity cannot explain away
the expected relationship between the life cycle and the corporate risk-taking.
In support of the instruments, we also conduct underidentification, weak
identification, Hansen’s overidentifying restrictions and Hausman’s endogene-
ity tests. In Table 6, underidentification test results (LM statistic) reveal that
the excluded instruments are ‘relevant’. The weak instrument test results show
that the excluded instruments are correlated with the endogenous regressors
because the (corrected) Cragg–Donald Wald F-statistic (185.05) is greater than
Stock and Yogo (2005) critical value (i.e. 29.18) at 10 percent. It is worth noting
that Stock and Yogo (2005) provide critical values only for a range of possible
circumstances up to three endogenous regressors. However, there are four
endogenous regressors (proxies for four LCS) in Dickinson (2011) life cycle
measures, and thus, Stock and Yogo (2005) cannot provide critical value in this
circumstance. To address this problem, we follow the approach proposed by
Angrist and Pischke (2008) and recently modified by Sanderson and
Windmeijer (2013) and estimate a corrected version of the first-stage F-statistic
that is suitable for our setting of more than three endogenous variables. Our
corrected Cragg–Donald Wald F-statistic shows that a weak instrument is not a
concern with our estimates. Results from Hansen’s overidentifying restrictions
test do not reject the null hypothesis (p > 0.10), suggesting that instruments are
uncorrelated with the error term and are correctly excluded from the second-
stage regression, which reflects the validity of the instruments used for the 2SLS
regression. Finally, Hausman (1978) test significantly rejects (p < 0.001) the
exogeneity of the firm life cycle proxies, justifying the use of the 2SLS
regression estimates. Using industry life cycle variables and firm-level variables
(organisational capital and a loss dummy variable that takes a value of 1 if
there is operating loss in a given year), we also perform 2SLS for STD_RET
and R&D/TA and inference remains the same.
4.5. Robustness tests
4.5.1. Alternative life cycle proxy and corporate risk-taking
As a robustness check, we test the association between firm life cycle and
corporate risk-taking using the alternative life cycle measure of DeAngelo et al.
(2006). They argue that firms with a high retained earnings to total assets ratio
(RE/TA) are typically more mature, or old with declining investment, whilst
firms with a low RE/TA tend to be young and growing. Therefore, they argue
© 2015 AFAANZ
that RE/TA is an appropriate firm life cycle proxy.6 The coefficients on RE/TA
are 0.013, 0.001 and 0.033 (all at p < 0.001) for the risk-taking proxies of
R&D/TA, STD_RET and STD_ROA, respectively. Thus, regression results
imply that, compared to young and growing firms, corporate risk-taking is
negative and significant for mature stage firms.
4.5.2. Alternative sentiment index
We use the Michigan Consumer Sentiment Index (MCSI) developed by the

University of Michigan and obtained from the Federal Reserve Economic Data
as an alternative sentiment index. Every month the MCRC administers opinion
surveys of households around the country. The survey uses a Likert scale to
gauge perceptions on personal financial welfare, on countrywide financial
welfare, and on consumer spending. Responses to the monthly survey questions
are combined to form an overall measure of sentiment, the MCSI. The higher
the value is the more confidence consumers have about the overall economy.
Our untabulated results are generally consistent with the findings using the
Baker and Wurgler (2006) sentiment index. The coefficient on SENT is
0.000 045 with a t-statistic of 5.65. The interactive coefficients of SENT with
four life cycle proxies yield results similar to the Baker and Wurgler (2006)
measure. Coefficients on INTRO*SENT and GROWTH*SENT are positive
and significant at better than the 5 percent level. Coefficients on MATURE*-
SENT (DECLINE*SENT) are negative (positive) and are significant at better
than the 1 percent level.
4.5.3. Macroeconomic determinants of corporate risk-taking
One plausible explanation for the relationship between firm life cycle and
corporate risk-taking could be that risk-taking responds to macroeconomic
factors, and omission of these variables could give rise to correlated omitted-
variable problem. Furthermore, extant studies show that macroeconomic
variables influence innovation, survival and stock return volatility of the firm
(Errunza and Hogan, 1998; Everett and Watson, 1998). To rule out the
possibility that macroeconomic factors could drive the result, we included
three macroeconomic variables, namely inflation, industrial production
growth and growth in real GDP in regression Equations (1) and (2).
Untabulated regression coefficients show that inflation and industrial
production growth are significantly positively associated with risk-taking,
whilst real GDP growth is significantly negatively associated. However, the
6
One may argue that RE/TA captures the effect of firm age, which is already one of the
control variables in our regression models. To allay this concern, we test the pairwise
correlation between AGE and RE/TA (q = 0.0073), which suggests that these two are
not capturing the same construct.
© 2015 AFAANZ
coefficient and statistical significance on LCS measures remain virtually

unchanged.
4.5.4. Accruals quality and corporate risk-taking
In another robustness test, we included accruals quality as a misvaluation

proxy that might affect risk-taking and, hence, provide a plausible alternative
explanation (Polk and Sapienza, 2009). We regressed different proxies for risk-
taking on accruals quality (modified Jones model of Dechow et al., 1995), LCS
and other control variables. The coefficient on accruals quality is negative and
significant at the 1 percent level. Importantly, the coefficients and statistical
significance of all the life cycle variables remain qualitatively unchanged.
5. Conclusions
This study examines firm LCS as potential determinants of corporate risk-

taking and investigates the possibility that prevalent investor sentiment might
moderate any association between the two. Managerial risk-taking has
important implications for firm growth, performance and survival (Bromiley,
1991), yet has the potential to cause serious agency problems by accepting
value-destroying negative NPV projects and/or foregoing positive NPV
projects. Managers have incentives to remain conservative in their investments
because of the concentration of their human capital in one particular
organisation. Prior research on the determinants of corporate risk-taking has
primarily focused on the executive compensation structure. Although this
stream of research is insightful in understanding whether properly designed
executive compensation attenuates investment distortions by managers, it does
not consider the dynamic nature of the organisational life cycle and its impact
on corporate risk-taking. We fill this void in the literature.
We use the Dickinson (2011) parsimonious life cycle measure as our primary
independent variable. We use three different measures of risk and find that
managerial risk-taking is higher during the introduction and decline stages of
the firm life cycle compared to the shake-out stage benchmark. Risk-taking is
lower during the growth and maturity phases of the firm life cycle. With regard
to the effect of risk-taking on future performance, we find that future
performance worsens for risk-taking during the early phase (introduction) and
decline phase of the firm LCS but improves for risk-taking during growth and
mature stages. We also examine whether the association between risk-taking
and firm LCS is moderated by investor sentiment. We argue that in a period of
high investor sentiment, market mispricing could encourage managers to take
on excessive risks in order to cater to high investor expectation. We find that
early-stage firms as well as firms in the decline stage assume more risk during
periods of high investor sentiment.
© 2015 AFAANZ
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Appendix
Variable definitions and measurement
Variables Definition and measurement
Dependent variable
STD_ROA Standard deviation of return on assets, measured as the standard deviation of the
income before tax and extraordinary items (PI – XI) scaled by total assets (AT),
over the prior 3 years
STD_RET Annual standard deviation of monthly stock returns, computed from return data
(RET) from the CRSP
R&D/TA Research and Development expense (XRD) scaled by total asset (AT)
Firm life cycle proxies
CLC A vector of dummy variables that capture firms’ different stages in the life cycle
RE/TA Retained earnings (RE) as a proportion of total assets
Investor sentiment
SENT An indicator variable coded 1 for high sentiment period and zero otherwise. High
sentiment periods are 1987–88, 1996–97, 1999–01, 2004 and 2006–07. Investor
sentiment is based on the common variation in six underlying proxies for sentiment:
the closed-end fund discount, NYSE share turnover, the number and average of
first-day returns on IPOs, the equity share in new issues and the dividend
premium (Baker and Wurgler, 2006). As each sentiment proxy is likely to include
a sentiment component as well as idiosyncratic components, the authors use
principal components analysis to isolate the common component.
Control variables
SIZE Natural logarithm of market value of equity (PRCC_F*CSHO)

MTB Market-to-book ratio, measured as market value of equity (PRCC_F*CSHO)
scaled by book-value of equity (CEQ)
LEV Leverage, measured as total long-term debt (DLTT) scaled by total asset (AT)
CAPEX Capital expenditure (CAPX) scaled by market value of asset (PRCC_F*CSHO
+ DLTT)
DSALE Changes in sales (SALE) scaled by lagged sales (SALE)
AGE Age is measured as the number of years since the firm was first covered by the
Center for Research in Securities Prices (CRSP) (DATADATE – BEGDAT).
For regression analysis, we measure AGE as natural log of (1+ age of the firm)
PM Profit margin, measured as income before tax and extraordinary items (PI – XI)
scaled by sales (SALE)
Year Dummy variables to control for fiscal year
IND Dummy variables to control for industry effect
© 2015 AFAANZ

Firm Life Cycle, Corporate Risk-Taking and Investor Sentiment

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Firm Life Cycle, Corporate Risk-Taking and Investor Sentiment

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Accounting and Finance

Firm life cycle, corporate risk-taking and investor

Ahsan Habiba, Mostafa Monzur Hasanb

This study investigates the corporate risk-taking and the performance

JEL classification: D21, G12, G30

This study investigates empirically the corporate risk-taking propensities at

Corporate risk-taking is the amount of uncertainty associated with expected

4.4. Two-stage least squares regression

Even though regression estimates suggest signiﬁcant negative (positive)

investment. The study of Dickinson (2011) also suggests that decline-stage

With respect to proﬁtability during growth phase, it is suggested that as

As risk-taking in the form of capital investments requires access to

3. Research design and sample description

3.1. Sample and data

3.2. Empirical model

We estimate the following regression model to test the relationship between

where RISK, corporate risk-taking measures; LCSDUM, a vector of dummy

Panel A: data and sample

Industry Total number of observations % of observations

Panel B: industry distribution

Business equipment 27 205 22.48

and decline, respectively (this sequence of coeﬃcients of LCS is also applicable

(CRSP) (DATADATE – BEGDAT). For regression analysis, we measure AGE

Our dependent variable is 1-year-ahead ROA, a proxy for ﬁrm proﬁtability.

We interact an investor sentiment proxy with ﬁrm LCS to evaluate the

3.3. Explanatory variables: estimation of firm life cycle proxies

(1) Introduction: if OCF < 0, INVCF < 0 and FINCF ˃ 0;

(2) Growth: if OCF ˃ 0, INVCF < 0 and FINCF ˃ 0;

3.4 Dependent variable: estimation of firm risk-taking

Motivated by prior literature, we employ three measures of corporate risk-

3.5. Control variables

Prior studies suggest that managerial investment behaviour is impacted by

Li et al. (2013) show that ﬁrm-level leverage is negatively associated with

4.1. Descriptive statistics

Table 2 presents descriptive statistics for the variables included in the

Panel A: pooled descriptive statistics

Panel B: correlation analysis

Variable INTRO GROWTH MATURE SHAKE-OUT DECLINE

STD_ROA 0.235 0.105 0.147 0.003 0.114

MTB 0.057 0.014 0.033 0.036 0.003

All variables, except those in italics, are signiﬁcant at p < 0.001.

4.2. Regression results

Panel A: firm life cycle and corporate risk-taking

Constant ? 0.17*** 0.07*** 0.08*** 0.06*** 0.06*** 0.03

[25.93] [85.07] [13.99] [24.76] [63.73] [9.42]

With ‘STRATEGY’ included

CAPEX + 0.008 0.011*** 0.16*** 0.00* 0.01*** 0.16

Panel B: firm life cycle, executive compensation and risk-taking

INTRO + 0.03*** 0.006*** 0.03*** 0.03*** 0.004*** 0.02***

[7.79] [12.74] [9.26] [6.71] [5.21] [6.01]

***p < 0.01, **p < 0.05, *p < 0.10.

that the coeﬃcient on COMP*GROWTH is positive and signiﬁcant for two

Model (1) Model (2) Model (3)

Constant 0.05*** 0.06*** 0.06*

4.4. Two-stage least squares regression

Even though regression estimates suggest signiﬁcant negative (positive)

Model (1) Model (2) Model (3)

Intercept ? 0.27*** 0.07*** 0.12***

Explanatory variable Introduction Growth Maturity Decline

Panel A: first-stage regressions of life cycle proxies and validity of instruments

Panel B: second-stage regressions of corporate risk-taking on life cycle proxy

included firm-level variable have a significant effect on firm LCS. Results in

4.5. Robustness tests

Constant ? 0.17* 0.07* 0.08* 0.06* 0.06*** 0.03

CAPEX + 0.008 0.011* 0.16* 0.00* 0.01*** 0.16

INTRO + 0.03* 0.006* 0.03* 0.03* 0.004* 0.02*

p < 0.01, p < 0.05, p < 0.10.

Constant 0.05* 0.06* 0.06*

Intercept ? 0.27* 0.07* 0.12***