Dynamic Q-Theory with Agency Investment Frictions and Cross-Sectional Stock Returns

51 Pages Posted: 3 Dec 2015 Last revised: 26 Jan 2016

Lei Mao

University of Warwick - Finance Group

Mike Qinghao Mao

Erasmus University Rotterdam

K. C. John Wei

Hong Kong University of Science & Technology (HKUST)

Date Written: December 1, 2015

Abstract

We investigate the impact of managerial investment diversion on a firm’s investment paths and the investment-return relation in a dynamic q-theory model. When efficiency of investment is not observed by shareholders, the manager may divert investment for private benefits. An agency investment friction emerges from the cost associated with high-powered managerial compensations to prevent the investment diversion. The state-dependency of agency investment frictions predicts cross-sectional variations in the relation between investment and subsequent stock returns. Our empirical results are consistent with the model predictions and suggest that managerial agency costs influence investment levels and stock returns across U.S. firms.

Keywords: Dynamic agency, Q-theory of investment, Cross-section of stock returns

JEL Classification: G12; G14; G34; D82

Suggested Citation

Mao, Lei and Mao, Mike Qinghao and Wei, K. C. John, Dynamic Q-Theory with Agency Investment Frictions and Cross-Sectional Stock Returns (December 1, 2015). WBS Finance Group Research Paper No. 0001. Available at SSRN: https://ssrn.com/abstract=2683926

Lei Mao (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain

Mike Qinghao Mao

Erasmus University Rotterdam ( email )

Burgemeester Oudlaan 50
3000 DR Rotterdam, Zuid-Holland 3062PA
Netherlands
+31104081322 (Phone)

K.C. John Wei

Hong Kong University of Science & Technology (HKUST)

Clearwater Bay
Kowloon
Hong Kong

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