Working Paper: CEPR ID: DP12690
Authors: Josef Falkinger; Michel Antoine Habib
Abstract: When should shareholders afford a manager the discretion to be opportunistic and when should they constrain him to be principled? We show that discretion is associated with lower powered incentives than is constraint: opportunism may put shareholder capital at risk; shareholder can lessen that risk by lowering the power of managerial incentives, thereby decreasing the manager's incentives to spurn principle for opportunity. We further show that the cost of capital plays a central role in favoring discretion over constraint: the use of capital constitutes an externality; when the cost of capital is low, the externality is of relatively little importance, and the manager is afforded the discretion to be opportunistic.
Keywords: No keywords provided
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| managerial discretion (M54) | lower powered incentives (L97) |
| lower powered incentives (L97) | risk to shareholder capital (G32) |
| cost of capital (G31) | discretion (Y60) |
| cost of capital (G31) | constraints (D10) |
| discretion (Y60) | risk to shareholder capital (G32) |
| lower managerial incentives (M52) | reduce manager's motivation to prioritize opportunism (L21) |
| cost of capital is low (G31) | discretion favored over constraint (D10) |
| cost of capital exceeds threshold (G31) | necessity for constraints (D10) |
| quality of information (L15) | influence on causal dynamics (C32) |
| costs of evaluating risky investments (G11) | influence on causal dynamics (C32) |