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Corporate Finance 1 (Fach) / 11 Investment Distortions (Lektion)
- How do Investment distortions arise? Investment distortions arise out of conflicts of interest and asymmetric information
- Different examples of agency problems between a firm‘s management and its shareholders Empire building Perk consumption Reputation
- Perk Consumption Managers tend to appropriate perquisites („perks“) out of the firm‘s resources for their own consumption
- Managerial Entrenchment Entrenchment means that managers make themselves valuable to shareholders and costly to replace.
- Manager-Specific Investments A manager has an incentive to invest the firm‘s resources in assets whose value is higher under him than under the best alternative manager
- DEF: irreversibility + a high degree of irreversibility ensures what? the fraction of the value that cannot be recovered by reselling them. A high degree of irreversibility ensures that the incumbent manager remains valuable to shareholders
- Managerial Reputation - Herd Behavior negative expected value --> pursue it if others before him have. positive expected value --> refuse if others before him have
- Managerial Reputation - Conservatism Why does a manager may, for instance, seek safe projects? lower probability of early conspicious failure --> damage the manager‘s reputation.
- Myopia (Kurzsichtigkeit) When the manager‘s compensation or reputation is based on the firm‘s cash flows, the manager can be induced to select projects that produce high cash flows relatively early Symptom: above-market discount rates or the payback criterion
- Long-Termism yield cash flows or resolve project uncertainty in such a distant future that they delay resolution of uncertainty about the manager‘s ability
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