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Dynamic Agency and Investment Theory under Model Uncertainty

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  • Yingjie Niu
  • Jinqiang Yang
  • Zhentao Zou

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

  • Yingjie Niu & Jinqiang Yang & Zhentao Zou, 2019. "Dynamic Agency and Investment Theory under Model Uncertainty," International Review of Finance, International Review of Finance Ltd., vol. 19(2), pages 447-458, June.
    • Handle: RePEc:bla:irvfin:v:19:y:2019:i:2:p:447-458
    DOI: 10.1111/irfi.12170
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    Cited by:

    1. Wu, Ting & He, Linfeng & Zhang, Fan, 2021. "Endogenous discounting, investment and Tobin’s q," The North American Journal of Economics and Finance, Elsevier, vol. 55(C).
    2. Ma, Jinrun & Niu, Yingjie, 2019. "The timing and intensity of investment under ambiguity," The North American Journal of Economics and Finance, Elsevier, vol. 49(C), pages 318-330.
    3. Niu, Yingjie & He, Linfeng & Wu, Wei, 2021. "Managerial compensation with hyperbolic discounting," Finance Research Letters, Elsevier, vol. 38(C).
    4. Ma, Jinrun & Wu, Yaoyao & Liang, Yongtang, 2023. "Robust investment and hedging policy with limited commitment," Economic Modelling, Elsevier, vol. 125(C).
    5. Niu, Yingjie & Yang, Jinqiang & Zou, Zhentao, 2020. "Robust contracts with one-sided commitment," Journal of Economic Dynamics and Control, Elsevier, vol. 117(C).
    6. Wang, Yuli & Niu, Yingjie, 2020. "Ambiguity aversion for risk choice," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).

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