DP9147 Agency, Firm Growth and Managerial Turnover

Author(s): Ronald W. Anderson, Maria Cecilia Bustamante, Stéphane Guibaud
Publication Date: September 2012
Keyword(s): agency, compensation policy, firm growth, managerial turnover, optimal contracting, severance pay
JEL(s): G30, G35
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=9147

We study managerial incentive provision under moral hazard in a firm subject to stochastic growth opportunities. In our model, managers are dismissed after poor performance, but also when an alternative manager is more capable of growing the firm. The optimal contract may involve managerial entrenchment, such that growth opportunities are foregone after good performance. Firms with better growth prospects have higher managerial turnover and more front-loaded compensation. Firms may pay severance to incentivize their managers to report truthfully the arrival of growth opportunities. By ignoring the externality of the dismissal policy onto future managers, the optimal contract implies excessive retention.