IDEAS home Printed from https://ideas.repec.org/p/rco/dpaper/62.html
   My bibliography  Save this paper

Size Matters - \'Over\'investments in a Relational Contracting Setting

Author

Listed:
  • Englmaier, Florian

    (LMU Munich)

  • Fahn, Matthias

    (JKU Linz)

Abstract

The corporate finance literature documents that managers tend to over-invest in their companies. A number of theoretical contributions have aimed at explaining this stylized fact, most of them focusing on a fundamental agency problem between shareholders and managers. The present paper shows that over-investments are not necessarily the (negative) consequence of agency problems between shareholders and managers, but instead might be a second-best optimal response to address problems of limited commitment and limited liquidity. If a firm has to rely on relational contracts to motivate its workforce, and if it faces a volatile environment, investments into general, non-relationship-specific, capital can increase the efficiency of a firm\'s labor relations.

Suggested Citation

  • Englmaier, Florian & Fahn, Matthias, 2018. "Size Matters - \'Over\'investments in a Relational Contracting Setting," Rationality and Competition Discussion Paper Series 62, CRC TRR 190 Rationality and Competition.
    • Handle: RePEc:rco:dpaper:62
    as

    Download full text from publisher

    File URL: https://rationality-and-competition.de/wp-content/uploads/discussion_paper/62.pdf
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Roman Inderst & Manuel Klein, 2007. "Innovation, endogenous overinvestment, and incentive pay," RAND Journal of Economics, RAND Corporation, vol. 38(4), pages 881-904, December.
    2. Jeremy C. Stein, 1989. "Efficient Capital Markets, Inefficient Firms: A Model of Myopic Corporate Behavior," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 104(4), pages 655-669.
    3. Jensen, Michael C, 1986. "Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers," American Economic Review, American Economic Association, vol. 76(2), pages 323-329, May.
    4. Bargeron, Leonce L. & Schlingemann, Frederik P. & Stulz, René M. & Zutter, Chad J., 2008. "Why do private acquirers pay so little compared to public acquirers?," Journal of Financial Economics, Elsevier, vol. 89(3), pages 375-390, September.
    5. Grossman, Sanford J & Hart, Oliver D, 1983. "An Analysis of the Principal-Agent Problem," Econometrica, Econometric Society, vol. 51(1), pages 7-45, January.
    6. Matthias Fahn & Valeria Merlo & Georg Wamser, 2019. "The Commitment Role of Equity Financing," Journal of the European Economic Association, European Economic Association, vol. 17(4), pages 1232-1260.
    7. Bengt Holmstrom, 1979. "Moral Hazard and Observability," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 74-91, Spring.
    8. J B Heaton, 2002. "Managerial Optimism and Corporate Finance," Financial Management, Financial Management Association, vol. 31(2), Summer.
    9. HOLMSTROM, Bengt, 1979. "Moral hazard and observability," LIDAM Reprints CORE 379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    10. Jonathan Levin, 2002. "Multilateral Contracting and the Employment Relationship," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(3), pages 1075-1103.
    11. Klein, Benjamin & Leffler, Keith B, 1981. "The Role of Market Forces in Assuring Contractual Performance," Journal of Political Economy, University of Chicago Press, vol. 89(4), pages 615-641, August.
    12. Roll, Richard, 1986. "The Hubris Hypothesis of Corporate Takeovers," The Journal of Business, University of Chicago Press, vol. 59(2), pages 197-216, April.
    13. MacLeod, W Bentley & Malcomson, James M, 1989. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment," Econometrica, Econometric Society, vol. 57(2), pages 447-480, March.
    14. Myers, Stewart C., 2003. "Financing of corporations," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 4, pages 215-253, Elsevier.
    15. Bebchuk, Lucian Arye & Stole, Lars A, 1993. "Do Short-Term Objectives Lead to Under- or Overinvestment in Long-Term Projects?," Journal of Finance, American Finance Association, vol. 48(2), pages 719-729, June.
    16. Hart, Oliver & Moore, John, 1995. "Debt and Seniority: An Analysis of the Role of Hard Claims in Constraining Management," American Economic Review, American Economic Association, vol. 85(3), pages 567-585, June.
    17. Marina Halac, 2015. "Investing in a relationship," RAND Journal of Economics, RAND Corporation, vol. 46(1), pages 165-185, March.
    18. Roni Michaely & Michael R. Roberts, 2012. "Corporate Dividend Policies: Lessons from Private Firms," The Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 711-746.
    19. Clive Bull, 1987. "The Existence of Self-Enforcing Implicit Contracts," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 102(1), pages 147-159.
    20. Jin Li & Niko Matouschek, 2013. "Managing Conflicts in Relational Contracts," American Economic Review, American Economic Association, vol. 103(6), pages 2328-2351, October.
    21. Abreu, Dilip, 1988. "On the Theory of Infinitely Repeated Games with Discounting," Econometrica, Econometric Society, vol. 56(2), pages 383-396, March.
    22. Michael Powell, 2019. "Productivity and credibility in industry equilibrium," RAND Journal of Economics, RAND Corporation, vol. 50(1), pages 121-146, March.
    23. McConnell, John J. & Muscarella, Chris J., 1985. "Corporate capital expenditure decisions and the market value of the firm," Journal of Financial Economics, Elsevier, vol. 14(3), pages 399-422, September.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Matthias Fahn & Valeria Merlo & Georg Wamser, 2019. "The Commitment Role of Equity Financing," Journal of the European Economic Association, European Economic Association, vol. 17(4), pages 1232-1260.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Englmaier, Florian & Fahn, Matthias, 2014. "Size Matters - “Over†investments in a Relational Contracting Setting," Discussion Paper Series of SFB/TR 15 Governance and the Efficiency of Economic Systems 506, Free University of Berlin, Humboldt University of Berlin, University of Bonn, University of Mannheim, University of Munich.
    2. Matthias Fahn & Valeria Merlo & Georg Wamser, 2019. "The Commitment Role of Equity Financing," Journal of the European Economic Association, European Economic Association, vol. 17(4), pages 1232-1260.
    3. Daniel Barron & Jin Li & Michał Zator, 2022. "Morale and Debt Dynamics," Management Science, INFORMS, vol. 68(6), pages 4496-4516, June.
    4. An, Suwei, 2023. "Essays on incentive contracts, M&As, and firm risk," Other publications TiSEM dd97d2f5-1c9d-47c5-ba62-f, Tilburg University, School of Economics and Management.
    5. Matthias Fahn & Nicolas Klein, 2019. "Relational Contracts with Private Information on the Future Value of the Relationship: The Upside of Implicit Downsizing Costs," American Economic Journal: Microeconomics, American Economic Association, vol. 11(4), pages 33-58, November.
    6. Jonathan Levin, 2003. "Relational Incentive Contracts," American Economic Review, American Economic Association, vol. 93(3), pages 835-857, June.
    7. Ola Kvaløy & Trond E. Olsen, 2012. "The Rise of Individual Performance Pay," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 21(2), pages 493-518, June.
    8. George Baker & Robert Gibbons & Kevin J. Murphy, 1994. "Subjective Performance Measures in Optimal Incentive Contracts," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 109(4), pages 1125-1156.
    9. Aldashev, Gani & Zanarone, Giorgio, 2017. "Endogenous enforcement institutions," Journal of Development Economics, Elsevier, vol. 128(C), pages 49-64.
    10. Taylan Mavruk & Evert Carlsson, 2015. "How long is a long-term-firm investment in the presence of governance mechanisms?," Eurasian Business Review, Springer;Eurasia Business and Economics Society, vol. 5(1), pages 117-149, June.
    11. W. Bentley MacLeod & Teck Yong Tan, 2016. "Optimal Contracting with Subjective Evaluation: The Effects of Timing, Malfeasance and Guile," NBER Working Papers 22156, National Bureau of Economic Research, Inc.
    12. Eduard Marinov, 2016. "The 2016 Nobel Prize in Economics," Economic Thought journal, Bulgarian Academy of Sciences - Economic Research Institute, issue 6, pages 97-149.
    13. Matthias Fahn & Giorgio Zanarone, 2022. "Transparency in relational contracts," Strategic Management Journal, Wiley Blackwell, vol. 43(5), pages 1046-1071, May.
    14. Rahaman, Mohammad M., 2014. "Do managerial behaviors trigger firm exit? The case of hyperactive bidders," The Quarterly Review of Economics and Finance, Elsevier, vol. 54(1), pages 92-110.
    15. Francesc Dilmé & Daniel F. Garrett, 2023. "Relational Contracts: Public versus Private Savings," Econometrica, Econometric Society, vol. 91(3), pages 1025-1075, May.
    16. Shleifer, Andrei & Vishny, Robert W, 1997. "A Survey of Corporate Governance," Journal of Finance, American Finance Association, vol. 52(2), pages 737-783, June.
    17. Robert Gibbons, 2010. "Inside Organizations: Pricing, Politics, and Path Dependence," Annual Review of Economics, Annual Reviews, vol. 2(1), pages 337-365, September.
    18. Stein, Jeremy C., 2003. "Agency, information and corporate investment," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 2, pages 111-165, Elsevier.
    19. Damien S Eldridge, 2007. "A Shirking Theory of Referrals," Working Papers 2007.05, School of Economics, La Trobe University.
    20. Lang, Matthias, 2019. "Communicating subjective evaluations," Journal of Economic Theory, Elsevier, vol. 179(C), pages 163-199.

    More about this item

    Keywords

    relational contracts; corporate finance; capital investments;
    All these keywords.

    JEL classification:

    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:rco:dpaper:62. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Viviana Lalli (email available below). General contact details of provider: https://rationality-and-competition.de .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.