Large Breach Penalties and Managers´ Incentives to Invest Inside or Outside Firms

Nicola Meccheri ()

Journal of Institutional and Theoretical Economics (JITE), 2009, vol. 165, issue 4, 598-621

Abstract: Managers´ incentives to invest in firms´ specific activities (internal investments) are compared with those to realize activities to increase their alternative market opportunities (external investments) when a managerial contract establishes a large breach penalty in the event of employment termination and wage bargaining occurs according to the outside-option principle. First, it is shown that internal and external investments are incentive substitutes from the manager´s viewpoint. Furthermore, large breach penalties against firms reduce managers´ incentives to invest inside (and raise those to invest outside) the incumbent employment relationship. By contrast, large breach penalties against managers perform better in enhancing managers´ firm-specific investments.

JEL-codes: G30 J24 J38 J41 (search for similar items in EconPapers)
Date: 2009
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