SIZE MATTERS: HOW OVER-INVESTMENTS RELAX LIQUIDITY CONSTRAINTS IN RELATIONAL CONTRACTS

The corporate finance literature documents that managers tend to over-invest in their companies. A number of theoretical contributions have aimed at explaining this stylised fact and most have focused on a fundamental agency problem between shareholders and managers. This article shows that over-inv...

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Bibliographic Details
Published in:The Economic journal (London) 2019-11, Vol.129 (624), p.3092-3106
Main Authors: Englmaier, Florian, Fahn, Matthias
Format: Article
Language:English
Subjects:
Agency theory
Capital
Corporate finance
Economic theory
Financial planners
Investment
Investments
Labor relations
Liquidity
Stockholders
Workforce
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Summary:The corporate finance literature documents that managers tend to over-invest in their companies. A number of theoretical contributions have aimed at explaining this stylised fact and most have focused on a fundamental agency problem between shareholders and managers. This article 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, then investments into general, non-relationship-specific capital can increase the efficiency of a firm’s labour relations.
ISSN:0013-0133
1468-0297
DOI:10.1093/ej/uez029