Measuring Investment Distortions When Risk-Averse Managers Decide Whether to Undertake Risky Projects

40 Pages Posted: 24 Apr 2005

See all articles by Robert Parrino

Robert Parrino

University of Texas at Austin - Department of Finance

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

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Abstract

We create a dynamic model in which a self-interested, risk-averse manager makes corporate investment decisions at a levered firm with characteristics typical of public US firms. We examine the magnitude of distortions in those decisions when a new project changes firm risk and find expected changes in the values of future tax shields and bankruptcy costs to be important factors. We evaluate the extent to which these distortions vary with firm leverage, debt duration, project size, managerial risk aversion, managerial non-firm wealth, and the structure of management compensation packages.

JEL Classification: G31, G34, G32, G35, J33, H25

Suggested Citation

Parrino, Robert and Poteshman, Allen M. and Weisbach, Michael S., Measuring Investment Distortions When Risk-Averse Managers Decide Whether to Undertake Risky Projects. Financial Management, Vol. 34, No. 1, Spring 2005. Available at SSRN: https://ssrn.com/abstract=704026

Robert Parrino (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-5788 (Phone)
512-471-5073 (Fax)

Allen M. Poteshman

University of Illinois at Urbana-Champaign - Department of Finance ( email )

340 Wohlers Hall
1206 South Sixth Street
Champaign, IL 61820
United States
217-265-0565 (Phone)
217-244-3102 (Fax)

HOME PAGE: http://www.business.uiuc.edu/poteshma

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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