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RFS Advance Access published online on March 21, 2008
Review of Financial Studies, doi:10.1093/rfs/hhn029
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© The Author 2008. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please email: journals.permissions@oxfordjournals.org

Motivating Entrepreneurial Activity in a Firm

Antonio E. Bernardo
1UCLA Anderson School of Management

Hongbin Cai
2Guanghua School of Management and Institute of Economic Policy Research, Peking University

Jiang Luo
3Nanyang Business School, Nanyang Technological University

Address correspondence to Antonio E. Bernardo, UCLA Anderson School of Management, 110 Westwood Plaza Box 951481, Los Angeles, CA 90095-1481; telephone (310) 825-2198; fax (310) 206-4119; e-mail: abernard{at}anderson.ucla.edu

JEL Classification: D82, D86, G31


  Abstract

We examine the problem of motivating privately informed managers to engage in entrepreneurial activity to improve the quality of the firm's investment opportunities. The firm's investment and compensation policy must balance the manager's incentives to provide entrepreneurial effort and to report private information truthfully. The optimal policy is to underinvest (compared to first-best) and provide weak incentive pay in low-quality projects and overinvest (compared to first-best) and provide strong incentive pay in high-quality projects.

We thank Li Jin, Charles Kahn, Christian Laux, an anonymous referee, the editor, and seminar participants at Boston College, Duke University, University of Illinois at Urbana-Champaign, Singapore Management University, Stanford University, University of California, San Diego, Washington University, EFA 2006 in Zurich, and China International Conference in Finance 2006 in Xi'an for helpful comments. Antonio Bernardo thanks the Harold and Pauline Price Center for Entrepreneurial Studies at the UCLA Anderson School of Management for research support. All errors are ours.


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