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Risk Sharing and the Theory of the Firm

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  • Alan J. Marcus

Abstract

When effort cannot be costlessly monitored, Pareto optimal employee compensation schemes require that owners and managers deviate from perfect risk sharing to improve the work incentives facing the manager. This article investigates the implications of this misallocation of risk for the behavior of firms in which managers make decisions for owners. The presented model predicts that, from the owner's perspective, managers will exhibit excessive risk aversion and underinvest in risky projects.

Suggested Citation

  • Alan J. Marcus, 1982. "Risk Sharing and the Theory of the Firm," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 369-378, Autumn.
  • Handle: RePEc:rje:bellje:v:13:y:1982:i:autumn:p:369-378
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    Cited by:

    1. Manish Gupta, 2011. "Dividends and Cost of Capital - An Empirical Study on REITs," ERES eres2011_56, European Real Estate Society (ERES).
    2. Abe, Naohito & Gaston, Noel & Kubo, Katsuyuki, 2005. "Executive pay in Japan: the role of bank-appointed monitors and the Main Bank relationship," Japan and the World Economy, Elsevier, vol. 17(3), pages 371-394, August.
    3. Esty, Benjamin C., 1998. "The impact of contingent liability on commercial bank risk taking," Journal of Financial Economics, Elsevier, vol. 47(2), pages 189-218, February.
    4. Polinsky, A Mitchell, 1987. "Fixed Price versus Spot Price Contracts: A Study in Risk Allocation," Journal of Law, Economics, and Organization, Oxford University Press, vol. 3(1), pages 27-46, Spring.
    5. Yermack, David, 1995. "Do corporations award CEO stock options effectively?," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 237-269.
    6. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.

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