Measuring Investment Distortions When Risk-Averse Managers Decide Whether to Undertake Risky Projects
University of Texas at Austin - Department of Finance
Allen M. Poteshman
University of Illinois at Urbana-Champaign - Department of Finance
Michael S. Weisbach
Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)
NBER Working Paper No. w8763
This paper examines distortions in corporate investment decisions when a new project changes firm risk. It presents a dynamic model in which a self-interested, risk-averse manager makes investment decisions at a levered firm. The model, calibrated using data from public firms, is used to estimate the magnitude of distortions in investment decisions. Despite potential wealth transfers from debtholders, managers compensated with equity prefer safe projects to risky ones. Important factors in this decision are the expected changes in the values of future tax shields and bankruptcy costs when firm risk changes. We also evaluate the extent to which this effect varies with firm leverage, managerial risk aversion, managerial non-firm wealth, project size, debt duration, and the structure of management compensation packages.
Number of Pages in PDF File: 56working papers series
Date posted: February 2, 2002
© 2013 Social Science Electronic Publishing, Inc. All Rights Reserved.
This page was processed by apollo3 in 0.422 seconds