Moral Hazard, Investment, and Firm Dynamics
University of Minnesota - Carlson School of Management
Purdue University - Department of Economics; University of Wisconsin - Madison
January 11, 2012
AFA 2013 San Diego Meetings Paper
We present a dynamic general equilibrium model with heterogeneous firms. Owners of firms delegate investment decisions to managers, whose consumption and investment decisions are private information. We solve the optimal contracts and characterize the implied firm dynamics. Risk sharing requires that managers' equity share decrease with firm size. This in turn implies that it is harder to prevent private benefit in larger firms, where managers have lower equity stake under the optimal contract. Consequently, smaller firms invest more, pay less dividends, and grow faster. Quantitatively, we show that our model is consistent with the Pareto-like size distribution of firms in the data, as well as the pattern of the relationships between firm size and firms' investment and dividend policies.
Number of Pages in PDF File: 54
Keywords: Moral Hazard, Dynamic Contracting, General Equilibrium, Firm Dynamics
JEL Classification: E13, G30working papers series
Date posted: March 12, 2012 ; Last revised: May 20, 2012
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo2 in 0.703 seconds