Working Paper: NBER ID: w7335
Authors: Rajesh K. Aggarwal; Andrew A. Samwick
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.
Keywords: No keywords provided
JEL Codes: G3; J3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| private benefits (J32) | overinvest (G31) |
| private costs (H49) | underinvest (G31) |
| managerial incentives (M52) | firm performance (L25) |
| managerial incentives (M52) | investment (G31) |
| firm performance (L25) | investment (G31) |