Dynamic Agency and Real Options

Time: Tuesday January 15th, 13.00-14.00 hours
Location: CPB-office, Van Stolkweg 14, The Hague

Presentation: Sebastian Gryglewicz (EUR)

Discussant: Gijsbert Zwart (CPB)

Language: English

Registration:  Please register by sending an email to seminars@cpb.nl.

Abstract subject: We present a model of a firm facing a dynamic moral hazard problem in which the firm also has access to a real option. The firm's risk averse manager can exert costly hidden effort to increase productivity growth. In addition, the risk neutral owners of the firm can irreversibly increase the firm's capital stock. In contrast to the literature, moral hazard may accelerate or delay investment relative to the first best depending on the severity of the moral hazard problem. When the agency problem is more severe, the firm will invest at a lower threshold than in the first best case because investment acts as substitute for effort. This mechanism provides an explanation for over-investment that does not rely on “empire building'' preferences. Effort decreases after investment, however pay performance sensitivity increases after investment when the agency problem is less severe and the growth option is large.

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