Investment and CEO Compensation Under Limited Commitment

62 Pages Posted: 1 Nov 2013

See all articles by Hengjie Ai

Hengjie Ai

University of Minnesota - Carlson School of Management; University of Minnesota - Twin Cities - Carlson School of Management

Rui Li

University of Wisconsin - Madison; Purdue University - Department of Economics

Date Written: August 20, 2013

Abstract

We extend the neoclassical investment model Hayashi (1982) to allow for limited commitment on compensation contracts. We consider three types of limited commitment: i) managers cannot commit to compensation contracts that provide lower continuation utility than their outside options; ii) shareholders cannot commit to negative net present value projects; iii) limited commitment on both the manager and the shareholder sides. We characterize the optimal contract under general convex adjustment cost functions and provide examples where closed form solutions can be obtained. We show that consistent with empirical evidence, small firms invest more, grow faster, have higher Tobin's Q, and are less likely to pay dividends than large firms do under the optimal contract.

Keywords: Dynamic Contracting, Limited Commitment, Investment, Q-Theory

JEL Classification: G30

Suggested Citation

Ai, Hengjie and Ai, Hengjie and Li, Rui and Li, Rui, Investment and CEO Compensation Under Limited Commitment (August 20, 2013). Available at SSRN: https://ssrn.com/abstract=2347494 or http://dx.doi.org/10.2139/ssrn.2347494

Hengjie Ai (Contact Author)

University of Minnesota - Carlson School of Management ( email )

321 19th Avenue South
Minneapolis, MN 55455
United States

University of Minnesota - Twin Cities - Carlson School of Management ( email )

19th Avenue South
Minneapolis, MN 55455
United States

Rui Li

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Purdue University - Department of Economics ( email )

West Lafayette, IN 47907-1310
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
86
Abstract Views
878
rank
364,478
PlumX Metrics