Dynamic Agency and Investment Theory under Model Uncertainty1. (4th January 2018)

• Record Type: Journal Article
• Authors: Niu, Yingjie; Yang, Jinqiang; Zou, Zhentao
• Is Part Of: International review of finance. Volume 19:Number 2(2019:Jun.)
• Page Start: 447
• Page End: 458
• Publication Date: 2018-01-04
• Subjects: Finance -- Periodicals; Financial institutions -- Periodicals; 332.673
• DOI: 10.1111/irfi.12170
• Languages: English
• ISSNs: 1369-412X

Abstract

Abstract: We extend dynamic agency and investment theory by incorporating model uncertainty. As concerns regarding model uncertainty induce a trade‐off between incentives and ambiguity sharing, the principal tends to delay the cash payout to the agent. We find model uncertainty lowers the firm value, the average q and marginal q, where q is defined as the ratio between a physical asset's market value and its replacement value. Furthermore, model uncertainty leads to insufficient investment, which provides an alternative explanation for under‐investment. Finally, the optimal pay‐performance sensitivity of the agent's continuation value to the firm's output is state dependent and exceeds the lower bound when it is close to the payout boundary.