Financial development, agency and the pace of adoption of new techniques
AbstractWe study the relation of financial development and the pace of technological advance in a dynamic agency theoretic model. A firm which is financed by outside shareholders but run by managers has the prospect of a process innovation which arrives stochastically. Adopting the innovation requires firing old management and hiring new with skills appropriate for the new technique. We show that subgame perfect equilibria in this game can be of two types. In entrenchment equilibrium once the new techniques has been announced old style management raises their dividend payout sufficiently to pre-empt the innovation. In maximum rent extraction equilibrium managers are unable or unwilling to match the impending productivity improvement and instead respond by increasing their perquisites for the remaining time of their tenure. We show that both equilibria involve several types of inefficiencies and can result in underinvestment in positive NPV projects. We discuss the role of financial innovation in reducing the inefficiencies identified.
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Bibliographic InfoPaper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 25065.
Length: 32 pages
Date of creation: Aug 2001
Date of revision:
Other versions of this item:
- Kjell G. Nyborg & Ron Anderson, 2001. "Financial Development, Agency and the Pace of Adoption of New Techniques," FMG Discussion Papers dp389, Financial Markets Group.
- F3 - International Economics - - International Finance
- G3 - Financial Economics - - Corporate Finance and Governance
- J1 - Labor and Demographic Economics - - Demographic Economics
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