The Network Effects of Agency Conflicts

51 Pages Posted: 13 Apr 2020 Last revised: 14 Feb 2021

See all articles by Rakesh Vohra

Rakesh Vohra

University of Pennsylvania - Department of Economics

Yiqing Xing

Johns Hopkins University - Carey Business School

Wu Zhu

University of Pennsylvania

Date Written: March 18, 2020

Abstract

It is customary to focus on the network of interdependencies between firms to understand how and whether a shock to one firm will propagate to others. This paper argues that agency conflicts at the firm-level and not just the network structure, play a crucial role in amplifying or muting the propagation of exogenous shocks. If firms can take investment decisions in response to an exogenous shock, whether their choices amplify or mute the propagation of the shock will depend on the nature of the agency conflict. When agents in our model are subject to default costs or limited liability, they make investment choices that serve to mitigate the spread of an initial shock. In the face of interest conflicts or moral hazard, however, shocks are amplified by firm-level investment choices.

The presence of these agency conflicts counters the role of network structure in the propagation of shocks. For example, prior work argues that denser or more integrated networks facilitate the propagation of shocks. We show that in the presence of interest conflicts, this effect can be reversed. Under some conditions, the aggregate effect of an idiosyncratic shock via propagation does not diminish. This suggests a potentially important role that corporate governance plays in macro fluctuations.

Keywords: Financial Network, Systemic Risk, Financial Crisis, Investment Decision, Conflict of Interest, Moral Hazard

JEL Classification: D85, F36,G32,G33,G38

Suggested Citation

Vohra, Rakesh and Xing, Yiqing and Zhu, Wu, The Network Effects of Agency Conflicts (March 18, 2020). Available at SSRN: https://ssrn.com/abstract=3556298 or http://dx.doi.org/10.2139/ssrn.3556298

Rakesh Vohra

University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States

Yiqing Xing

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

HOME PAGE: http://yiqingxing.com

Wu Zhu (Contact Author)

University of Pennsylvania ( email )

Philadelphia, PA 19104
United States

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