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In search of a unicorn: Dynamic agency with endogenous investment opportunities

Author

Listed:
  • Feng, Felix Zhiyu
  • Luo, Robin Yifan
  • Michaeli, Beatrice

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.

Suggested Citation

  • Feng, Felix Zhiyu & Luo, Robin Yifan & Michaeli, Beatrice, 2024. "In search of a unicorn: Dynamic agency with endogenous investment opportunities," Journal of Accounting and Economics, Elsevier, vol. 78(2).
    • Handle: RePEc:eee:jaecon:v:78:y:2024:i:2:s0165410124000685
    DOI: 10.1016/j.jacceco.2024.101738
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    More about this item

    Keywords

    Dynamic agency; Endogenous search; Overinvestment;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • M11 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Business Administration - - - Production Management

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