Measuring Investment Distortions when Risk-Averse Managers Decide Whether to Undertake Risky Projects / Robert Parrino, Allen M. Poteshman, Michael S. Weisbach.

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Parrino, Robert

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Material type: Text

TextSeries: Working Paper Series (National Bureau of Economic Research) ; no. w8763.Publication details: Cambridge, Mass. National Bureau of Economic Research 2002.Description: 1 online resource: illustrations (black and white)Subject(s):

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Abstract: This paper examines distortions in corporate investment decisions when a new project changes firm risk. It presents a dynamic model in which a self-interested, risk-averse manager makes investment decisions at a levered firm. The model, calibrated using data from public firms, is used to estimate the magnitude of distortions in investment decisions. Despite potential wealth transfers from debtholders, managers compensated with equity prefer safe projects to risky ones. Important factors in this decision are the expected changes in the values of future tax shields and bankruptcy costs when firm risk changes. We also evaluate the extent to which this effect varies with firm leverage, managerial risk aversion, managerial non-firm wealth, project size, debt duration, and the structure of management compensation packages.

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Item type	Home library	Collection	Call number	Status	Date due	Barcode	Item holds
Working Paper	Biblioteca Digital	Colección NBER	nber w8763 (Browse shelf(Opens below))	Not For Loan

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January 2002.

This paper examines distortions in corporate investment decisions when a new project changes firm risk. It presents a dynamic model in which a self-interested, risk-averse manager makes investment decisions at a levered firm. The model, calibrated using data from public firms, is used to estimate the magnitude of distortions in investment decisions. Despite potential wealth transfers from debtholders, managers compensated with equity prefer safe projects to risky ones. Important factors in this decision are the expected changes in the values of future tax shields and bankruptcy costs when firm risk changes. We also evaluate the extent to which this effect varies with firm leverage, managerial risk aversion, managerial non-firm wealth, project size, debt duration, and the structure of management compensation packages.