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Dynamic Agency and the q Theory of Investment

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  • PETER M. DEMARZO
  • MICHAEL J. FISHMAN
  • ZHIGUO HE
  • NENG WANG

Abstract

been profitable, agency concerns are less severe, and the firm is growing rapidly. To study the effect of serial correlation of productivity shocks on investment and firm dynamics, we extend our model to allow the firm’s output price to be stochastic. We show that, in contrast to static agency models, the agent’s compensation in the optimal dynamic contract will depend not only on the firm’s past performance, but also on output prices, even though they are beyond the agent’s control. This dependence of the agent’s compensation on exogenous output prices (for incentive reasons) further feeds back on the firm’s investment, and provides a channel to amplify and propagate the response of investment to output price shocks via dynamic agency.

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File URL: http://hdl.handle.net/10.1111/j.1540-6261.2012.01787.x
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Bibliographic Info

Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 67 (2012)
Issue (Month): 6 (December)
Pages: 2295-2340

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Handle: RePEc:bla:jfinan:v:67:y:2012:i:6:p:2295-2340

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  1. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
  2. Diamond, Douglas W, 1984. "Financial Intermediation and Delegated Monitoring," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 393-414, July.
  3. Bruno Biais & Thomas Mariotti & Guillaume Plantin & Jean-Charles Rochet, 2007. "Dynamic Security Design: Convergence to Continuous Time and Asset Pricing Implications," Review of Economic Studies, Oxford University Press, vol. 74(2), pages 345-390.
  4. Biais, Bruno & Mariotti, Thomas & Plantin, Guillaume & Rochet, Jean Charles, 2004. "Dynamic Security Design," CEPR Discussion Papers 4753, C.E.P.R. Discussion Papers.
  5. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
  6. repec:bla:restud:v:74:y:2007:i:2:p:345-390 is not listed on IDEAS
  7. Spear, Stephen E & Srivastava, Sanjay, 1987. "On Repeated Moral Hazard with Discounting," Review of Economic Studies, Wiley Blackwell, vol. 54(4), pages 599-617, October.
  8. Russell Cooper & Joao Ejarque, 2003. "Financial Frictions and Investment: Requiem in Q," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(4), pages 710-728, October.
  9. Atkeson, Andrew, 1991. "International Lending with Moral Hazard and Risk of Repudiation," Econometrica, Econometric Society, vol. 59(4), pages 1069-89, July.
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