In Search of a Unicorn: Dynamic Agency with Endogenous Investment Opportunities

50 Pages Posted: 15 Dec 2021 Last revised: 13 Feb 2024

See all articles by Felix Zhiyu Feng

Felix Zhiyu Feng

University of Washington - Michael G. Foster School of Business

Robin Yifan Luo

University of Washington - Michael G. Foster School of Business

Beatrice Michaeli

University of California, Los Angeles (UCLA)

Date Written: January 31, 2024

Abstract

We study the optimal dynamic contract that provides incentives for an agent (e.g., SPAC sponsor, VC general partner, CTO) to exploit investment opportunities/targets that arrive randomly over time via a costly search process. The agent is privy to the arrival as well as to the quality of the target and can take advantage of this for rent extraction during the search process and the ensuing production. The optimal contract provides the agent with incentives for timely and truthful reporting via a time-varying threshold for investment and an internal charge for the time spent on search. In the equilibrium, as time elapses, the charge becomes progressively higher while the investment threshold is progressively lower, resulting in overinvestment at a time-varying degree. Our model generates empirically testable predictions regarding investments (such as M\&As, hedge fund activism, VC investing, SPACs, and internal innovations), linking the degree of overinvestment to observable firm and industry characteristics.

Keywords: dynamic agency, endogeneous search, project selection, overinvestment

JEL Classification: G31, D82, D83, D86, M11

Suggested Citation

Feng, Felix and Luo, Robin Yifan and Michaeli, Beatrice, In Search of a Unicorn: Dynamic Agency with Endogenous Investment Opportunities (January 31, 2024). Journal of Accounting & Economics (JAE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3983591 or http://dx.doi.org/10.2139/ssrn.3983591

Felix Feng (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

Robin Yifan Luo

University of Washington - Michael G. Foster School of Business ( email )

Seattle, WA 98195
United States

Beatrice Michaeli

University of California, Los Angeles (UCLA) ( email )

D410 Anderson Complex
Los Angeles, CA 90095
United States

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