Agency Costs, Firm Behaviour and the Nature of Competition
CEPR Working Paper No. 2130
Posted: 31 Jan 2000
Date Written: April 1999
This paper develops an agency model in which firms can influence their own incentives to provide a non-contractible effort by contracting on other variables (e.g. by committing themselves to some verifiable investment). In such a model the firms' need for outside finance is shown to interact with their product market behavior in a non-monotonic way; for low levels of outside finance a rise in the need for outside finance reduces the manager's incentive to provide effort; but for high initial levels of outside finance a rise in the need for outside finance requires a commitment to higher effort which in turn is achieved through the contractible investment variables. This non monotonicity has major implications for firm behavior, both when responding to demand shocks or when reacting to a change in the competitive environment.
JEL Classification: E0, L0, O0
Suggested Citation: Suggested Citation