Dynamic Agency and the q Theory of Investment

Peter M. Demarzo*, Michael J. Fishman, Zhiguo He, Neng Wang

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

135 Scopus citations


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.

Original languageEnglish (US)
Pages (from-to)2295-2340
Number of pages46
JournalJournal of Finance
Issue number6
StatePublished - Dec 1 2012

ASJC Scopus subject areas

  • Accounting
  • Finance
  • Economics and Econometrics


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