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Empire-Builders and Shirkers: Investment, Firm Performance, and Managerial Incentives

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Author Info
Rajesh K. Aggarwal
Andrew A. Samwick

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Abstract

Do firms systematically over- or underinvest as a result of agency problems? We develop a contracting model between shareholders and managers in which managers have private benefits or private costs of investment. Managers overinvest when they have private benefits and underinvest when they have private costs. Optimal incentive contracts mitigate the over- or underinvestment problem. We derive comparative static predictions for the equilibrium relationships between incentives from compensation, investment, and firm performance for both cases. The relationship between firm performance and managerial incentives, in isolation, is insufficient to identify whether managers have private benefits or private costs of investment. In order to identify whether managers have private benefits or costs, we estimate the joint relationships between incentives and firm performance and between incentives and investment. Our empirical results show that both firm performance and investment are increasing in managerial incentives. These results are consistent with managers having private costs of investment. We find no support for overinvestment based on private benefits.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 7335.

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Date of creation: Sep 1999
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Handle: RePEc:nbr:nberwo:7335

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G3 - Financial Economics - - Corporate Finance and Governance
J3 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs

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  1. Antoine Renucci, 2008. "Access to financing, rents, and organization of the firm," Post-Print halshs-00365983_v1, HAL. [Downloadable!]
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