Managerial diversion, product market competition, and firm performance

We derive the conditions under which a manager will divert and how managerial diversion affects product market performance and firm profits. Our model predicts that managerial diversion is more likely to occur and leads to more aggressive product market behavior in a firm with weak incentives and corporate governance. In these firms, the relation between managerial diversion and firm profits is inverse U-shaped. Chinese state-owned manufacturing firms are used to test our theoretical model, and we find supportive evidence.