Principle or Opportunism? Discretion, Capital, and Incentives

62 Pages Posted: 14 Feb 2018

See all articles by Josef Falkinger

Josef Falkinger

University of Zurich - Department of Economics

Michel A. Habib

University of Zurich; Swiss Finance Institute

Multiple version iconThere are 2 versions of this paper

Date Written: February 2018

Abstract

When should shareholders afford a manager the discretion to be opportunistic and when should they constrain him to be principled? We show that discretion is associated with lower powered incentives than is constraint: opportunism may put shareholder capital at risk; shareholder can lessen that risk by lowering the power of managerial incentives, thereby decreasing the manager's incentives to spurn principle for opportunity. We further show that the cost of capital plays a central role in favoring discretion over constraint: the use of capital constitutes an externality; when the cost of capital is low, the externality is of relatively little importance, and the manager is afforded the discretion to be opportunistic.

Suggested Citation

Falkinger, Josef and Habib, Michel A., Principle or Opportunism? Discretion, Capital, and Incentives (February 2018). CEPR Discussion Paper No. DP12690, Available at SSRN: https://ssrn.com/abstract=3122332

Josef Falkinger (Contact Author)

University of Zurich - Department of Economics ( email )

Zuerich, 8006
Switzerland

Michel A. Habib

University of Zurich ( email )

Plattenstrasse 14
Zurich, 8032
Switzerland
41-44-634-2507 (Phone)
41-44-634-4903 (Fax)

HOME PAGE: http://www.isb.uzh.ch/institut/profs/mhabib.htm

Swiss Finance Institute ( email )

c/o University of Geneva
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CH-1211 Geneva 4
Switzerland

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