Discussion Paper Details

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Title: Risky Investments with Limited Commitment

Author(s): Thomas F Cooley, Ramon Marimon and Vincenzo Quadrini

Publication Date: November 2013

Keyword(s): financial corporate governance, Financial risk, income inequality, limited commitment, managerial incentives and parnerships

Programme Area(s): Financial Economics and International Macroeconomics

Abstract: Over the last three decades there has been a dramatic increase in the size of the financial sector and in the compensation of financial executives. This increase has been associated with greater risk-taking and the use of more complex financial instruments. Parallel to this trend, the organizational structure of the financial sector has changed with the traditional partnership replaced by public companies. The organizational change has increased the competition for managerial talent, which may have weakened the commitment between investors and managers. We show how increased competition and the weaker commitment can raise the managerial incentives to undertake risky investment. In the general equilibrium, this change results in higher risk-taking, a larger and more productive financial sector with greater income inequality (within and across sectors), and a lower market valuation of financial institutions.

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Bibliographic Reference

Cooley, T, Marimon, R and Quadrini, V. 2013. 'Risky Investments with Limited Commitment'. London, Centre for Economic Policy Research.