Investment Policy, Financial Policies, and the Control of Agency Conflicts

38 Pages Posted: 12 Sep 2002

See all articles by Erwan Morellec

Erwan Morellec

Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute

Clifford W. Smith

Simon Graduate School of Business, University of Rochester

Date Written: October 2002

Abstract

This paper analyzes the interaction among investment, financing and hedging policies in a model where managers derive perquisites from investment. In our model, both hedging and financing policies affect a firm's investment policy, thus changing costs of over- and underinvestment. The paper demonstrates that combinations of financing and hedging policies typically better control deviations from value-maximization in investment policy than either of these policies taken individually. We show that this implies that when firm value depends on the firm's investment policy, shareholders generally have incentives to maintain the firm's hedging policy once debt has been issued. The paper also examines managers' risk-shifting incentives and provides an analysis of the benefits associated with risk management in different economic environments.

Keywords: Investment Policy, Financing Policy, Risk Management

JEL Classification: G12, G31, G32

Suggested Citation

Morellec, Erwan and Smith, Clifford W., Investment Policy, Financial Policies, and the Control of Agency Conflicts (October 2002). Simon School of Business Working Paper No. FR 02-16. Available at SSRN: https://ssrn.com/abstract=329201 or http://dx.doi.org/10.2139/ssrn.329201

Erwan Morellec (Contact Author)

Ecole Polytechnique Fédérale de Lausanne ( email )

College of Management
Extranef Quartier UNIL-Dorigny
1015 Lausanne, CH-1015
Switzerland

HOME PAGE: http://sfi.epfl.ch/

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Clifford W. Smith

Simon Graduate School of Business, University of Rochester ( email )

Carol Simon Hall 3-202C
Rochester, NY 14627
United States
585-275-3217 (Phone)
585-442-6323 (Fax)

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