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Agency, firm growth, and managerial turnover

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  • Ronald W. Anderson
  • Maria Cecilia Bustamante
  • Stéphane Guibaud
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    Abstract

    We study the relation between firm growth and managerial incentive provision under moral hazard when a long-lived firm is operated by a sequence of managers. In our model, firms replace their managers not only upon poor performance to provide incentives, but also when outside managers are at a comparative advantage to lead the firm through a new growth phase. We show how the optimal contract can be implemented with a system of deferred compensation credit and bonuses, along with dismissal and severance policies. Firms with better investment prospects have higher managerial turnover and rely on more front-loaded compensation schemes. Growth-induced turnover can result in positive severance if the principal needs to incentivize the manager to truthfully report the arrival of a growth opportunity. Realized firm growth depends jointly on the exogenous arrival of growth opportunities and the severity of the moral hazard problem. We also find a new component of agency costs due to the spillover effect of the tenure of the incumbent manager onto the present value of future managers’ compensation.

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    File URL: http://eprints.lse.ac.uk/43144/
    File Function: Open access version.
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    Bibliographic Info

    Paper provided by London School of Economics and Political Science, LSE Library in its series LSE Research Online Documents on Economics with number 43144.

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    Length: 49 pages
    Date of creation: 11 Jun 2012
    Date of revision:
    Handle: RePEc:ehl:lserod:43144

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    Postal: LSE Library Portugal Street London, WC2A 2HD, U.K.
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    Web page: http://www.lse.ac.uk/
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    Related research

    Keywords: Dynamic contracting; managerial turnover; growth; moral hazard;

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    1. 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.
    2. Dirk Jenter & Katharina Lewellen, 2011. "CEO Preferences and Acquisitions," CESifo Working Paper Series 3681, CESifo Group Munich.
    3. Gian Luca Clementi & Hugo Hopenhayn, 2002. "A Theory of Financing Constraints and Firm Dynamics," RCER Working Papers 492, University of Rochester - Center for Economic Research (RCER).
    4. Daniel Garrett & Alessandro Pavan, 2010. "Managerial Turnover in a Changing World," Discussion Papers 1490, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    5. Spear, Stephen E. & Wang, Cheng, 2005. "When to fire a CEO: optimal termination in dynamic contracts," Journal of Economic Theory, Elsevier, vol. 120(2), pages 239-256, February.
    6. Anderson, Ronald W. & Nyborg, Kjell G., 2011. "Financing and corporate growth under repeated moral hazard," Journal of Financial Intermediation, Elsevier, vol. 20(1), pages 1-24, January.
    7. Catherine Casamatta & Alexander Guembel, 2010. "Managerial Legacies, Entrenchment, and Strategic Inertia," Journal of Finance, American Finance Association, vol. 65(6), pages 2403-2436, December.
    8. Eisfeldt, Andrea & Kuhnen, Camelia M., 2010. "CEO turnover in a competitive assignment framework," MPRA Paper 22367, University Library of Munich, Germany.
    9. Bruno Biais & Thomas Mariotti & Jean-Charles Rochet & StÈphane Villeneuve, 2010. "Large Risks, Limited Liability, and Dynamic Moral Hazard," Econometrica, Econometric Society, vol. 78(1), pages 73-118, 01.
    10. Murphy, Kevin J. & Zimmerman, Jerold L., 1993. "Financial performance surrounding CEO turnover," Journal of Accounting and Economics, Elsevier, vol. 16(1-3), pages 273-315, April.
    11. Quadrini, Vincenzo, 2004. "Investment and liquidation in renegotiation-proof contracts with moral hazard," Journal of Monetary Economics, Elsevier, vol. 51(4), pages 713-751, May.
    12. Roman Inderst & Holger M. Mueller, 2010. "CEO Replacement Under Private Information," Review of Financial Studies, Society for Financial Studies, vol. 23(8), pages 2935-2969, August.
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