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: www.cepr.org/pubs/dps/DP2130.asp

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.