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Size Matters: How Over-Investments Relax Liquidity Constraints In Relational Contracts

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  • Englmaier, Florian
  • Fahn, Matthias

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 stylised fact and most have focused on a fundamental agency problem between shareholders and managers. This article 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, then investments into general, non-relationship-specific capital can increase the efficiency of a firm's labour relations.

Suggested Citation

  • Englmaier, Florian & Fahn, Matthias, 2019. "Size Matters: How Over-Investments Relax Liquidity Constraints In Relational Contracts," Munich Reprints in Economics 78215, University of Munich, Department of Economics.
    • Handle: RePEc:lmu:muenar:78215
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    Cited by:

    1. W. Bentley MacLeod & James M. Malcomson, 2023. "Implicit Contracts, Incentive Compatibility, and Involuntary Unemployment: Thirty Years On," Journal of Institutional and Theoretical Economics (JITE), Mohr Siebeck, Tübingen, vol. 179(3-4), pages 470-499.
    2. Matthias Fahn, 2019. "Reciprocity in dynamic employment relationships," CESifo Working Paper Series 7634, CESifo.
    3. Daniel Barron & Jin Li & Michał Zator, 2022. "Morale and Debt Dynamics," Management Science, INFORMS, vol. 68(6), pages 4496-4516, June.
    4. Francesc Dilmé & Daniel F. Garrett, 2023. "Relational Contracts: Public versus Private Savings," Econometrica, Econometric Society, vol. 91(3), pages 1025-1075, May.
    5. Joel Watson, 2021. "Theoretical Foundations of Relational Incentive Contracts," Annual Review of Economics, Annual Reviews, vol. 13(1), pages 631-659, August.

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