Working Paper: NBER ID: w8763
Authors: Robert Parrino; Allen M. Poteshman; Michael S. Weisbach
Abstract: This paper examines distortions in corporate investment decisions when a new project changes firm risk. It presents a dynamic model in which a self-interested, risk-averse manager makes investment decisions at a levered firm. The model, calibrated using data from public firms, is used to estimate the magnitude of distortions in investment decisions. Despite potential wealth transfers from debtholders, managers compensated with equity prefer safe projects to risky ones. Important factors in this decision are the expected changes in the values of future tax shields and bankruptcy costs when firm risk changes. We also evaluate the extent to which this effect varies with firm leverage, managerial risk aversion, managerial non-firm wealth, project size, debt duration, and the structure of management compensation packages.
Keywords: No keywords provided
JEL Codes: G3; H2
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| manager's risk aversion (D81) | preference for safe projects (G11) |
| manager's risk aversion (D81) | investment decisions (G11) |
| changes in firm risk (G32) | managerial utility (L97) |
| manager's risk aversion (D81) | preference for projects that lower firm risk (G32) |
| high leverage ratios (G32) | incentives to accept negative NPV projects (G31) |
| wealth transfer effects (H23) | acceptance of risky projects (D81) |
| managerial risk aversion (D81) | likelihood of accepting safer projects (H43) |