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Letting Go: Managerial Incentives and the Reallocation of Capital

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  • Adriano A. Rampini
  • Andrea L. Eisfeldt

Abstract

This paper studies the provision of incentives to reallocate capital when managers are reluctant to relinquish control and have private information about the productivity of assets under their control. We show that when managers get private benefits from running projects substantial bonuses are required to induce managers to declare that capital under their control is less productive and should be reallocated. When aggregate productivity and hence the number of projects is low and fewer managers are required to run projects such bonuses would leave managers with unnecessary rents. This means that it is more costly to induce reallocation and thus less capital is reallocated. From the investor's perspective, capital is more illiquid in bad times since too much of the gains from capital reallocation would accrue to managers.

Suggested Citation

  • Adriano A. Rampini & Andrea L. Eisfeldt, 2004. "Letting Go: Managerial Incentives and the Reallocation of Capital," 2004 Meeting Papers 611, Society for Economic Dynamics.
  • Handle: RePEc:red:sed004:611
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    References listed on IDEAS

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    Cited by:

    1. Inderst, Roman & Mueller, Holger M, 2006. "CEO Compensation and Strategy Inertia," CEPR Discussion Papers 5713, C.E.P.R. Discussion Papers.
    2. Almeida, Heitor & Wolfenzon, Daniel, 2006. "Should business groups be dismantled? The equilibrium costs of efficient internal capital markets," Journal of Financial Economics, Elsevier, vol. 79(1), pages 99-144, January.

    More about this item

    Keywords

    capital reallocation; business cycles; corporate finance; managerial incentives;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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