Firm size – incentives and investment
What happens when a risk-averse principal delegates the management of a firm to a risk-averse agent and offers the agent a long-term contract with full commitment?
Tekst: Sigrid Folkestad
In his paper «The impact of firm size on dynamic incentives and investment» postdoctoral fellow Chang-Koo Chi (see reference) studies how firm size affects the optimal contract and investment decision when the size evolves over time with a diminishing volatility.
This paper is included in the NHH exclusive list of international outlets. Researchers at NHH who publish in these journals receive a publication bonus of NOK 80 000.
By incorporating a capital accumulation process into a dynamic agency model, the article provides a unified framework where one can explore the impact of the regularity on both moral hazard and investment.
Recent empirical studies conclude that the dynamics of a firm are negatively associated with size.
It is now well documented, according to Chi and his coauthor, that within an industry, small firms grow faster but have a higher volatility of growth rates than large firms. Interpreting the volatility as corporate risk, this empirical pattern—referred to as the size-dependence regularity by Cooley and Quadrini (2001)—implies that the degree of risk a corporation faces depends on its size.
Then, in a dynamic agency problem in which firm size changes over time, this regularity has important implications for moral hazard and investment, as both are inextricably linked with the characteristic of shocks.
reference
«The impact of firm size on dynamic incentives and investment» by postdoctoral fellow Chang-Koo Chi and Kyoung Jin Choi. This paper has been accepted for publication in RAND Journal of Economics and was published online February 2017.
In this article, they propose a continuous-time principal-agent model in which firm size follows a diffusion process with a diminishing volatility of the growth rate, which sheds light on the impact of the regularity on dynamic incentives and investment.