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Investment timing decisions of managers under endogenous contracts

Keiichi Hori () and Hiroshi Osano

Journal of Corporate Finance, 2014, vol. 29, issue C, 607-627

Abstract: This paper considers what kind of managerial compensation contract is optimal for mitigating the moral hazard decision regarding investment timing. We examine the situation where the personal objectives of managers do not align with those of shareholders and where there is the possibility of project liquidation but where managerial compensation is endogenously determined. Using a real options approach, we show that restricted stock is optimal relative to stock options under various circumstances. However, we also suggest that stock options are more likely to be used instead of, or in addition to, restricted stock in firms with new debt financing and more impatient managers, diversified firms involving more complicated business activities, and firms with weaker corporate governance. In addition, we find that project start-up is more likely to be deterred by the greater likelihood of project liquidation and larger managerial effort cost, whereas the amount of stock-based managerial compensation is independent of the probability of liquidation but is increasing in managerial effort cost.

Keywords: Agency conflicts; Investment timing; Real options; Restricted stock; Stock options (search for similar items in EconPapers)
JEL-codes: D86 G30 G34 M52 (search for similar items in EconPapers)
Date: 2014
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Handle: RePEc:eee:corfin:v:29:y:2014:i:c:p:607-627