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Dynamic Agency and the q Theory of Investment

Author

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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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Suggested Citation

  • Peter M. Demarzo & Michael J. Fishman & Zhiguo He & Neng Wang, 2012. "Dynamic Agency and the q Theory of Investment," Journal of Finance, American Finance Association, vol. 67(6), pages 2295-2340, December.
    • Handle: RePEc:bla:jfinan:v:67:y:2012:i:6:p:2295-2340
    DOI: j.1540-6261.2012.01787.x
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