Size Matters - 'Over'investments in a Relational Contracting Setting

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

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 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.

• Item Type: Paper
• Keywords: relational contracts; corporate finance; capital investments
• Faculties: Economics > Collaborative Research Center Transregio "Rationality and Competition"
• Subjects: 300 Social sciences > 330 Economics
• JEL Classification: C73, D21, D86, G32
• Language: English