Journal Article

Agency Problems and Endogenous Investment Fluctuations

Giovanni Favara

in The Review of Financial Studies

Published on behalf of The Society for Financial Studies

Volume 25, issue 7, pages 2301-2342
Published in print July 2012 | ISSN: 0893-9454
Published online March 2012 | e-ISSN: 1465-7368 | DOI: https://dx.doi.org/10.1093/rfs/hhs009
Agency Problems and Endogenous Investment Fluctuations

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  • Macroeconomics: Consumption, Saving, Production, Employment, and Investment
  • Prices, Business Fluctuations, and Cycles
  • Economics
  • Financial Institutions and Services

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This article proposes a theory of investment fluctuations in which the source of the oscillating dynamics is an agency problem between financiers and entrepreneurs. In the model, investment decisions depend on entrepreneurs' initiative to select investment projects ex ante, and financiers' incentive to control entrepreneurs ex post. Too much control discourages entrepreneurial incentive to initiate new investment, whereas too little control jeopardizes its productivity. This initiative-control trade-off is capable of generating endogenous reversal of investment booms, induced by an ongoing deterioration of project profitability. Investment fluctuations may arise even though no external shocks hit the economy and agents are perfectly rational.

Keywords: E22; E30; E32; G14; G20

Journal Article.  17088 words.  Illustrated.

Subjects: Macroeconomics: Consumption, Saving, Production, Employment, and Investment ; Prices, Business Fluctuations, and Cycles ; Economics ; Financial Institutions and Services

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