Agency, Firm Growth and Managerial Turnover

Abstract

We study managerial incentive provision under moral hazard in an environment where growth opportunities arrive stochastically over time and taking them requires a change of management. The firm faces a trade-off between the benefit of always having a manager able to seize new opportunities and the cost of incentive provision. The optimal dynamic contract may grant partial job protection whereby the firm insulates its managers from the risk of growth-induced dismissal and foregoes attractive opportunities when they come after periods of good performance. Moreover, the prospect of growth-induced turnover limits the firm’s ability to rely on deferred pay — resulting in more front-loaded compensation. The empirical evidence for the U.S. is broadly supportive of the model’s predictions. Firms with better growth prospects experience higher CEO turnover and use more front-loaded compensation.

Keywords: dynamic contracting, managerial turnover, growth, moral hazard

JEL Classification: G30, D82, D86, D92