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Structural Models and Endogeneity in Corporate Finance: the Link Between Managerial Ownership and Corporate Performance

  • Coles, Jeffrey
  • Lemmon, Michael
  • Meschke, Felix

This paper presents a parsimonious, structural model that captures primary economic determinants of the relation between firm value and managerial ownership. Supposing that observed firm size and managerial pay-performance sensitivity (PPS) maximize value, we invert our model to panel data on size and PPS to obtain estimates of the productivity of physical assets and managerial input. Variation of these productivity parameters, optimizing firm size and compensation contract, and the way the parameters and choices interact in the model, all combine to deliver the well-known hump-shaped relation between Tobin’s Q and managerial ownership (e.g., McConnell and Servaes (1990)). Our structural approach illustrates how a quantitative model of the firm can isolate important aspects of organization structure, quantify the economic significance of incentive mechanisms, and minimize the endogeneity and causation problems that so commonly plague empirical corporate finance. Doing so appears to be essential because, by simulating panel data from the model and applying standard statistical tools, we confirm that the customary econometric remedies for endogeneity and causation can be ineffective in application.

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File URL: https://mpra.ub.uni-muenchen.de/4374/1/MPRA_paper_4374.pdf
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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 4374.

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Date of creation: 15 Feb 2007
Date of revision: 15 Feb 2007
Handle: RePEc:pra:mprapa:4374
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