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Investment, idiosyncratic risk, and ownership

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  • Vasia Panousi
  • Dimitris Papanikolaou

Abstract

High-powered incentives may induce higher managerial effort, but they also expose managers to idiosyncratic risk. If managers are risk averse, they might underinvest when firm-specific uncertainty increases, leading to suboptimal investment decisions from the perspective of well-diversified shareholders. We empirically document that when idiosyncratic risk rises, firm investment falls, and more so when managers own a larger fraction of the firm. This negative effect of managerial risk aversion on investment is mitigated if executives are compensated with options rather than with shares or if institutional investors form a large part of the shareholder base.

Suggested Citation

  • Vasia Panousi & Dimitris Papanikolaou, 2011. "Investment, idiosyncratic risk, and ownership," Finance and Economics Discussion Series 2011-54, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgfe:2011-54
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    More about this item

    Keywords

    Investments; Risk; Uncertainty; Institutional investors; Stockholders;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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