DP2130 Agency Costs, Firm Behaviour and the Nature of Competition

Author(s): Philippe Aghion, Mathias Dewatripont, Patrick Rey
Publication Date: April 1999
Keyword(s): Agency, Competition, Satisficing Behaviour
JEL(s): E0, L0, O0
Programme Areas: Financial Economics, Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=2130

This paper develops an agency model in which firms can influence their own incentives to provide a non-contractible effort by contracting on other variables (e.g. by committing themselves to some verifiable investment). In such a model the firms' need for outside finance is shown to interact with their product market behavior in a non-monotonic way; for low levels of outside finance a rise in the need for outside finance reduces the manager's incentive to provide effort; but for high initial levels of outside finance a rise in the need for outside finance requires a commitment to higher effort which in turn is achieved through the contractible investment variables. This non-monotonicity has major implications for firm behavior, both when responding to demand shocks or when reacting to a change in the competitive environment.