Dynamic Agency and Investment Theory Under Model Uncertainty

12 Pages Posted: 26 May 2020

See all articles by Yingjie Niu

Yingjie Niu

Shanghai University - SHU-UTS SILC Business School

Jinqiang Yang

Shanghai University of Finance and Economics

Zhentao Zou

Wuhan University - Economics and Management School

Date Written: June 2019

Abstract

We extend dynamic agency and investment theory by incorporating model uncertainty. As concerns regarding model uncertainty induce a trade‐off between incentives and ambiguity sharing, the principal tends to delay the cash payout to the agent. We find model uncertainty lowers the firm value, the average q and marginal q, where q is defined as the ratio between a physical asset's market value and its replacement value. Furthermore, model uncertainty leads to insufficient investment, which provides an alternative explanation for under‐investment. Finally, the optimal pay‐performance sensitivity of the agent's continuation value to the firm's output is state dependent and exceeds the lower bound when it is close to the payout boundary.

Suggested Citation

Niu, Yingjie and Yang, Jinqiang and Zou, Zhentao, Dynamic Agency and Investment Theory Under Model Uncertainty (June 2019). International Review of Finance, Vol. 19, Issue 2, pp. 447-458, 2019, Available at SSRN: https://ssrn.com/abstract=3603477 or http://dx.doi.org/10.1111/irfi.12170

Yingjie Niu (Contact Author)

Shanghai University - SHU-UTS SILC Business School ( email )

China

Jinqiang Yang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, P.R.China, AK Shanghai 200433
China

Zhentao Zou

Wuhan University - Economics and Management School ( email )

Hubei
China

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