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The Impact of Firm Size on Dynamic Incentives and Investment

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  • Chi, Chang Koo
  • Choi, Kyoung Jin

Abstract

Recent studies conclude that small firms have higher but more variable growth rates than large firms. To explore how this empirical regularity affects moral hazard and investment, we develop an agency model with a firm size process having two features: the drift is controlled by the agent's effort and the principal's investment decision, and the volatility is proportional to the square root of size. The firm improves on production efficiency as it grows, and wages are back-loaded when size is small but front-loaded when it is large. Furthermore, there is underinvestment in a small firm but overinvestment in a large firm.

Suggested Citation

  • Chi, Chang Koo & Choi, Kyoung Jin, 2016. "The Impact of Firm Size on Dynamic Incentives and Investment," MPRA Paper 80867, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:80867
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    References listed on IDEAS

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    More about this item

    Keywords

    Time-Varying Firm Size; Size-Dependence Regularity; Firm Size Effect; Dynamic Moral Hazard; Investment;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing

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