Dynamic Capital Allocation and Managerial Compensation

41 Pages Posted: 27 Jun 2016 Last revised: 11 Sep 2017

See all articles by Shiming Fu

Shiming Fu

School of Finance, Shanghai University of Finance and Economics

Date Written: July 1, 2017

Abstract

This paper proposes a dynamic theory of capital budgeting and compensation when investment information is decentralized and division manager can inefficiently deploy capital. The incentive cost and firm policies vary monotonically with stored liquidity. After bad performances, liquidity is low, positive NPV projects are foregone, and incentive is distorted downward. Projects with high return and high incentive cost may be monitored. As performance improves, liquidity becomes higher, fewer projects are forgone or monitored, and steeper incentive is provided. The model better explains the documented evidences that firm liquidity is positively correlated with incentive pay, and negatively with investment hurdle rates.

Keywords: Dynamic agency; Capital budgeting; Project choice; Pay-performance sensitivity; Monitoring

JEL Classification: D82, D86, G31, G35

Suggested Citation

Fu, Shiming, Dynamic Capital Allocation and Managerial Compensation (July 1, 2017). 27th Annual Conference on Financial Economics and Accounting Paper, Available at SSRN: https://ssrn.com/abstract=2800278 or http://dx.doi.org/10.2139/ssrn.2800278

Shiming Fu (Contact Author)

School of Finance, Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

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

Paper statistics

Downloads
143
Abstract Views
1,187
Rank
377,965
PlumX Metrics