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Integrated ownership and managerial incentives with endogenous project risk

Author

Listed:
  • Tim Baldenius

    (Columbia Business School)

  • Beatrice Michaeli

    (UCLA)

Abstract

Integrated ownership is often seen as a way to foster specific investments. However, even in integrated firms, managers invest to maximize their compensation, which is chiefly driven by divisional income. Thus it is not clear that integration has any effect on investments in a world of decentralized decision-making. Building on recent findings that efficiency-enhancing investments raise not only the expected value of a project but also its variance, we show that, under plausible conditions, integration calls for low-powered incentive contracts: the managers invest more as they are less exposed to the investment-related (endogenous) risk, and the principal of an integrated firm has more to gain from greater investment. On the other hand, integration may result in higher-powered incentives if the project is inherently very risky or if the project-specific input is personally costly to the managers (rather than a monetary investment). The qualitative takeaway remains, however, that the contract adjustments under integration mitigate any input distortions present under non-integration. We also allow for firmwide performance evaluation under integration and show that it may lead to larger input distortions, but those are outweighed by improved risk sharing.

Suggested Citation

  • Tim Baldenius & Beatrice Michaeli, 2019. "Integrated ownership and managerial incentives with endogenous project risk," Review of Accounting Studies, Springer, vol. 24(4), pages 1450-1485, December.
    • Handle: RePEc:spr:reaccs:v:24:y:2019:i:4:d:10.1007_s11142-019-09504-0
    DOI: 10.1007/s11142-019-09504-0
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    References listed on IDEAS

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    Cited by:

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    2. Bloomfield, Matthew J., 2021. "Compensation disclosures and strategic commitment: Evidence from revenue-based pay," Journal of Financial Economics, Elsevier, vol. 141(2), pages 620-643.

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    More about this item

    Keywords

    Firm ownership; Vertical integration; Pay-performance sensitivity; Investments; Risk; Firmwide performance evaluation;
    All these keywords.

    JEL classification:

    • M40 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - General
    • D23 - Microeconomics - - Production and Organizations - - - Organizational Behavior; Transaction Costs; Property Rights
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • L22 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Firm Organization and Market Structure

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