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Ambiguity, limited commitment, and the q theory of investment

Author

Listed:
  • Wu, Wei
  • Niu, Yingjie
  • Wu, Yaoyao
  • Xu, Hongru

Abstract

We consider the principal (shareholders)-agent (manager) problem in connection with investment and CEO compensation under two types of limited commitment, where the principal worries about model uncertainty and exhibits ambiguity-averse with respect to the true probability. Consistent with maxmin criterion, a robust principal makes decisions under some endogenous worst case. In the case of limited commitment on the manager side, the firm invests less and average q and marginal q are always lowered in the presence of ambiguity. However, in the case of limited commitment on the shareholder side, ambiguity induces under-investment and over-investment simultaneously and has different implications for average q and marginal q. Moreover, the robust compensation contract features time-varying compensation no matter whether the limited commitment constraints bind or not, which is contrary to the conventional wisdom. Finally, the optimal sensitivity of continuation utility increases with ambiguity-aversion.

Suggested Citation

  • Wu, Wei & Niu, Yingjie & Wu, Yaoyao & Xu, Hongru, 2022. "Ambiguity, limited commitment, and the q theory of investment," The North American Journal of Economics and Finance, Elsevier, vol. 60(C).
    • Handle: RePEc:eee:ecofin:v:60:y:2022:i:c:s1062940822000018
    DOI: 10.1016/j.najef.2022.101639
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    References listed on IDEAS

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    More about this item

    Keywords

    Ambiguity; Limited commitment; Investment; Compensation;
    All these keywords.

    JEL classification:

    • D8 - Microeconomics - - Information, Knowledge, and Uncertainty
    • G3 - Financial Economics - - Corporate Finance and Governance

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