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RFS Advance Access originally published online on May 15, 2006
Review of Financial Studies 2007 20(1):151-188; doi:10.1093/rfs/hhl004
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Right arrow D82 - Asymmetric and Private Information
Right arrow D86 - Economics of Contract: Theory
Right arrow D92 - Intertemporal Firm Choice and Growth, Investment, or Financing
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Agency and Optimal Investment Dynamics

Peter M. DeMarzo
Stanford University

Michael J. Fishman
Northwestern University

Address correspondence to Michael Fishman, Kellogg School of Management, Northwestern University, 2001 Sheridan Road, Evanston, IL 60208, or e-mail: m-fishman{at}kellogg.northwestern.edu.

Agency problems limit firms’ access to capital markets, curbing investment. Firms and investors seek contractual ways to mitigate these problems. What are the implications for investment? We present a theory of a firm’s investment dynamics in the presence of agency problems and optimal long-term financial contracts. We derive results relating firms’ investment decisions, current and past cash flows, firm size, capital structure, and dividends. Among the results, optimal investment is increasing in current and past cash flow; and optimal investment is positively serially correlated over time (after controlling for investment opportunities). These results hold for a range of agency problems. (JEL G30, G31, G32, G35, D82, D86, D92)


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Home page
 REV FINANC STUDHome page
P. M. DeMarzo and M. J. Fishman
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