Uncertainty, Investment, and Managerial Incentives
37 Pages Posted: 4 Jul 2014 Last revised: 8 Oct 2016
Date Written: October 1, 2014
This study provides evidence that managerial incentives, shaped by compensation contracts, help to explain the empirical relationship between uncertainty and investment. We develop a model in which the manager, compensated with an equity-based contract, makes investment decisions for a firm that faces time-varying volatility. The contract creates incentives that affect both the sign and magnitude of a manager's optimal response to volatility shocks. The model is calibrated using compensation data to quantify this predicted investment response for a large panel of firms. Our estimates help explain the variation in firm-level investment responses to volatility shocks observed in the data.
Keywords: Uncertainty, Corporate Investment, Agency Conflicts, Moral Hazard
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