TY - JOUR
T1 - Dynamic Agency and the q Theory of Investment
AU - Demarzo, Peter M.
AU - Fishman, Michael J.
AU - He, Zhiguo
AU - Wang, Neng
PY - 2012/12/1
Y1 - 2012/12/1
N2 - We develop an analytically tractable model integrating dynamic investment theory with dynamic optimal incentive contracting, thereby endogenizing financing constraints. Incentive contracting generates a history-dependent wedge between marginal and average q, and both vary over time as good (bad) performance relaxes (tightens) financing constraints. Financial slack, not cash flow, is the appropriate proxy for financing constraints. Investment decreases with idiosyncratic risk, and is positively correlated with past profits, past investment, and managerial compensation even with time-invariant investment opportunities. Optimal contracting involves deferred compensation, possible termination, and compensation that depends on exogenous observable persistent profitability shocks, effectively paying managers for luck.
AB - We develop an analytically tractable model integrating dynamic investment theory with dynamic optimal incentive contracting, thereby endogenizing financing constraints. Incentive contracting generates a history-dependent wedge between marginal and average q, and both vary over time as good (bad) performance relaxes (tightens) financing constraints. Financial slack, not cash flow, is the appropriate proxy for financing constraints. Investment decreases with idiosyncratic risk, and is positively correlated with past profits, past investment, and managerial compensation even with time-invariant investment opportunities. Optimal contracting involves deferred compensation, possible termination, and compensation that depends on exogenous observable persistent profitability shocks, effectively paying managers for luck.
UR - http://www.scopus.com/inward/record.url?scp=84869742530&partnerID=8YFLogxK
UR - http://www.scopus.com/inward/citedby.url?scp=84869742530&partnerID=8YFLogxK
U2 - 10.1111/j.1540-6261.2012.01787.x
DO - 10.1111/j.1540-6261.2012.01787.x
M3 - Article
AN - SCOPUS:84869742530
SN - 0022-1082
VL - 67
SP - 2295
EP - 2340
JO - Journal of Finance
JF - Journal of Finance
IS - 6
ER -