Managerial Equity Incentives and the Investment-q Sensitivity

Abstract

We consider the effect of the agency problem between firm managers and shareholders on corporate investment. We derive investment regressions from a model of investment in which managers, who have control over corporate investment, have a preference to under- or overinvest. We show that these regressions are better-specified than traditional investment-q regressions, as they have significantly more explanatory power, and no investment-cashflow sensitivity. Our results show that executive compensation is used to combat managers' preference to underinvest, managers are more likely to underinvest at low levels of q and equity incentives are more powerful when investment incentives are low.

Keywords: CEO Compensation, Corporate Investment, Q Theory

JEL Classification: G32, E22