Managerial discretion and shareholder capital at risk

Josef Falkinger and Michel A. Habib

Journal of Business Finance & Accounting, 2021, vol. 48, issue 7-8, 1215-1245

Abstract: Managerial investment decisions put shareholder capital at risk. Shareholders respond either (i) by preserving the manager's discretion to choose among projects but decreasing the power of his (her) incentives, thereby decreasing the manager's gains from choosing risky projects, or (ii) by imposing a constraint on the type of project that the manager can undertake. We show that capital exposure—the extent to which managerial decisions put shareholder capital at risk—plays a central role in favoring the imposition of a constraint over the granting of discretion. We extend our analysis to consider other determinants of the choice between discretion and constraint.

Date: 2021
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