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Empire-Builders and Shirkers: Investment, Firm Performance, and Managerial Incentives

Rajesh Aggarwal and Andrew Samwick

No 7335, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Do firms systematically over- or underinvest as a result of agency problems? We develop a contracting model between shareholders and managers in which managers have private benefits or private costs of investment. Managers overinvest when they have private benefits and underinvest when they have private costs. Optimal incentive contracts mitigate the over- or underinvestment problem. We derive comparative static predictions for the equilibrium relationships between incentives from compensation, investment, and firm performance for both cases. The relationship between firm performance and managerial incentives, in isolation, is insufficient to identify whether managers have private benefits or private costs of investment. In order to identify whether managers have private benefits or costs, we estimate the joint relationships between incentives and firm performance and between incentives and investment. Our empirical results show that both firm performance and investment are increasing in managerial incentives. These results are consistent with managers having private costs of investment. We find no support for overinvestment based on private benefits.

JEL-codes: G3 J3 (search for similar items in EconPapers)
Date: 1999-09
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-ind and nep-lab
Note: CF IO
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5) Track citations by RSS feed

Published as Journal of Corporate Finance, Vol. 12, no. 3 (June 2006): 489-515

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