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Englmaier, Florian; Fahn, Matthias (2018): Size Matters - 'Over'investments in a Relational Contracting Setting. Collaborative Research Center Transregio 190, Discussion Paper No. 62


The corporate finance literature documents that managers tend to over-invest in their companies. A number of theoretical contributions have aimed at explaining this stylized fact, most of them focusing on a fundamental agency problem between shareholders and managers. The present paper 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, investments into general, non-relationship-specific, capital can increase the efficiency of a firm's labor relations.