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Financial Development, Agency and the Pace of Adoption of New Techniques

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  • Kjell G. Nyborg
  • Ron Anderson

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Abstract

We 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 Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp389.

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Date of creation: Aug 2001
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Handle: RePEc:fmg:fmgdps:dp389

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Web page: http://www.lse.ac.uk/fmg/

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  1. Jeremy Greenwood & Boyan Jovanovic, 1989. "Financial Development, Growth, and the Distribution of Income," NBER Working Papers 3189, National Bureau of Economic Research, Inc.
  2. Anderson, Ronald W & Nyborg, Kjell G, 2001. "Financing and Corporate Growth under Repeated Moral Hazard," CEPR Discussion Papers 2920, C.E.P.R. Discussion Papers.
  3. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1113-1155, December.
  4. Nobuhiro Kiyotaki & John Moore, 1995. "Credit Cycles," NBER Working Papers 5083, National Bureau of Economic Research, Inc.
  5. Banerjee, Abhijit V & Newman, Andrew F, 1991. "Risk-Bearing and the Theory of Income Distribution," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 211-35, April.
  6. Raghuram G. Rajan & Luigi Zingales, . "Financial Dependence and Growth," CRSP working papers 344, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
  7. Aghion, Philippe & Bolton, Patrick, 1992. "Distribution and growth in models of imperfect capital markets," European Economic Review, Elsevier, vol. 36(2-3), pages 603-611, April.
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Cited by:
  1. Ronald W. Anderson & Kjell G. Nyborg, 2002. "Agency and the Pace of Adoption of New Techniques," Recherches économiques de Louvain, De Boeck Université, vol. 68(1), pages 203-220.

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