Abstract
We incorporate large losses risks into the DeMarzo et al.(2012) model of dynamic agency and the q theory of investment. The large losses risks induce losses costs and losses arising from agency conflicts during the large losses prevention process. Both of them reduce firm’s value, distort investment policy and generate a deeper wedge between the marginal and average q. In addition, we study the implementation of the contract to enhance the practical utility of our model. The agent optimally manages the firm’s cash flow and treats the cash reservation and credit line as the firm’s financial slack, and hedges the productivity shocks and large losses shocks via futures and insurance contracts, respectively.
Article PDF
Similar content being viewed by others
Avoid common mistakes on your manuscript.
References
R Albuquerque, H Hopenhayn. Optimal lending contracts and firm dynamics, Rev Econom Stud, 2004, 71: 85–315.
B Biais, T Mariotti, G Plantin, JC Rochet. Dynamic security design: Convergence to continuous time and asset pricing implications, Rev Econom Stud, 2007, 74: 345–390.
B Biais, T Mariotti, JC Rochet, S Villeneuve. Large risks, limited liability, and dynamic moral hazard, Econometrica, 2010, 78: 73–118.
P Bolton, H Chen, N Wang. A unified theory of Tobin’s q, coporate investment, financing and risk management, J Finance, 2011, 66(5): 1545–1578.
P Bolton, H Chen, N Wang. Market timing, investment and risk management, J Financ Econ, 2013, 109(1): 40–62.
P Bolton, D Scharfstein. A theory of predation based on agency problems in financial contracting, Amer Econ Rev, 1990, 80: 94–106.
G L Clementi, HA Hopenhayn. A theory of financing constraints and firm dynamics, Quart J Econ, 2006, 121: 229–265.
P Demarzo, M J Fishman. Optimal long-term financial contracting with privately observed cash flows, Working paper, Stanford University.
P Demarzo, M J Fishman. Agency and optimal investment dynamics, Rev Financ Stud, 2007, 20(1): 151–188.
P Demarzo, M J Fishman. Agency and optimal investmnet dynamics, Rev Financ Stud, 2007a, 20: 151–188.
P Demarzo, M J Fishman. Optimal long-term financial contracting, Rev Financ Stud, 2007b, 20(6): 2079–2128.
P Demarzo, M J Fishman, ZG He, N Wang. Dynamic agency and the q theory of investment, J Finance, 2012, 67(6): 2295–2340.
RPE Gordon, R H Flin, K Mearns, MT Fleming. Assessing the human factors causes of accidents in the offshore oil industry, In: Proceedings of the 3rd International Conference on Health, Safety and Environment in Oil and Gas Exploration and Production, 1996.
F Hyashi. Tobin’s marginal q and average q: a neoclassical interpretation, Econometrica, 1982, 50: 213–224.
Z G He. Optimal executive compensation when firm size follows geometric Brownian motion, Rev Financ Stud, 2009, 22(2): 859–892.
F Hoffmann, S Pfeil. Reward for luck in a dynamic agency model, Rev Financ Stud, 2010, 23(9): 3329–3345.
E Hollnagel. Understanding accidents–from root causes to performance variability, In: Proceedings of the 7th IEEE Conference on Human Factors and Power Plants, 2002.
B Holmström, J Tirole. Financial intermediation, Loanable funds, and the real sector, Quart J Econ, 1997, 80: 663–691.
V Quadrini. Ivestment and liquidation in renegotiation-proof contracts with moral hazard, J Monetary Econ, 2004, 51: 713–751.
Y Sannikov. A continuous-time version of the principal-agent problem, Rev Econom Stud, 2008, 79: 957–984.
E S Spear, S Srivastava. On repeated moral hazard with discounting, Rev Econom Stud, 1987, 54: 599–617.
S E Shreve. Stochastic Calculus for Finance II: Continuous-Time Models, Springer, 2004.
Author information
Authors and Affiliations
Corresponding author
Additional information
Supported by the National Natural Science Foundation of China (11571310 and 71371168).
Rights and permissions
About this article
Cite this article
Wang, Y., Huang, Wl. & Li, Sh. When q theory meets large losses risks and agency conflicts. Appl. Math. J. Chin. Univ. 32, 477–492 (2017). https://doi.org/10.1007/s11766-017-3509-1
Received:
Revised:
Published:
Issue Date:
DOI: https://doi.org/10.1007/s11766-017-3509-1