Idiosyncratic Risk and the Manager

Oliver Levine and Brent Glover
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Oliver Levine: University of Wisconsin-Madison
Brent Glover: Carnegie Mellon University

No 736, 2014 Meeting Papers from Society for Economic Dynamics

Abstract: Compensating a manager with equity-based pay induces effort but also exposes the manager to firm-specific risk. In comparison to a diversified shareholder, this distorts the manager's discount rate and, in turn, investment and financing decisions. We embed this agency conflict in a structural model of the firm and estimate its effect on firm policies. We estimate the agency friction for a large panel of U.S. public firms and find significant cross-sectional and time-series variation in a manager's incentive to over- or under-invest. Our panel of incentive estimates helps to explain a broad set of empirical patterns, including investment, leverage, cash holdings, valuation ratios, and acquisition activity.

Date: 2014
New Economics Papers: this item is included in nep-hrm and nep-rmg
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