SIZE MATTERS: HOW OVER-INVESTMENTS RELAX LIQUIDITY CONSTRAINTS IN RELATIONAL CONTRACTS

Florian Englmaier and Matthias Fahn

Munich Reprints in Economics from University of Munich, Department of Economics

Abstract: The corporate finance literature documents that managers tend to over-invest in their companies. A number of theoretical contributions have aimed at explaining this stylised fact and most have focused on a fundamental agency problem between shareholders and managers. This article shows that over-investments are not necessarily the (negative) consequence of agency problems between shareholders and managers but instead might be a second-best optimal response to address problems of limited commitment and limited liquidity. If a firm has to rely on relational contracts to motivate its workforce and if it faces a volatile environment, then investments into general, non-relationship-specific capital can increase the efficiency of a firm's labour relations.

Date: 2019
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Citations: View citations in EconPapers (6)

Published in Economic Journal 624 129(2019): pp. 3092-3106

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Journal Article: Size Matters: How Over-Investments Relax Liquidity Constraints in Relational Contracts (2019)
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