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A Simple Model of Managerial Incentives and Portfolio-Investment Decision

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  • Deng, Binbin

Abstract

What is the optimal portfolio allocation when a manager is investing both for his firm and for himself? I address this question by solving a manager’s decision problem under a specific executive compensation structure. I study how flat wage and stock compensation affect the manager’s investment decision. I show that the allocation is the same regardless of whether the manager is prohibited from trading the public shares of his own firm. Results from calibration show that the manager invests less in firm-specific technology and more in the aggregate stock market as the risk of the firm’s project increases. More stock compensation discourages him from investing in the firm’s risky technology, but encourages more risk-taking in terms of personal investment. In addition, I prove that flat wage, effectively as a riskless bond, hedges risk and leads to more risk-taking behavior both in firm investment and personal investment.

Suggested Citation

  • Deng, Binbin, 2016. "A Simple Model of Managerial Incentives and Portfolio-Investment Decision," MPRA Paper 79959, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:79959
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    File URL: https://mpra.ub.uni-muenchen.de/79959/1/MPRA_paper_79959.pdf
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    References listed on IDEAS

    as
    1. Christian Lohmann, 2015. "Managerial incentives for capacity investment decisions," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 26(1), pages 27-49, April.
    2. David Hirshleifer, 1993. "Managerial Reputation and Corporate Investment Decisions," Financial Management, Financial Management Association, vol. 22(2), Summer.
    3. Efraim Benmelech & Eugene Kandel & Pietro Veronesi, 2010. "Stock-Based Compensation and CEO (Dis)Incentives," The Quarterly Journal of Economics, Oxford University Press, vol. 125(4), pages 1769-1820.
    4. William P. Rogerson, 2008. "Intertemporal Cost Allocation and Investment Decisions," Journal of Political Economy, University of Chicago Press, vol. 116(5), pages 931-950, October.
    5. Agrawal, Anup & Mandelker, Gershon N, 1987. " Managerial Incentives and Corporate Investment and Financing Decision s," Journal of Finance, American Finance Association, vol. 42(4), pages 823-837, September.
    6. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, vol. 79(2), pages 431-468, February.
    7. Glover, Brent & Levine, Oliver, 2015. "Uncertainty, investment, and managerial incentives," Journal of Monetary Economics, Elsevier, vol. 69(C), pages 121-137.
    8. Saltuk Ozerturk, 2006. "Managerial risk reduction, incentives and firm value," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(3), pages 523-535, April.
    Full references (including those not matched with items on IDEAS)

    More about this item

    Keywords

    managerial incentives; executive compensation; corporate investment; portfolio choice; asset allocation; dynamic optimization;

    JEL classification:

    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • M12 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Personnel Management; Executives; Executive Compensation

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