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Measuring Investment Distortions when Risk‐Averse Managers Decide Whether to Undertake Risky Projects
Author(s) -
Parrino Robert,
Poteshman Allen M.,
Weisbach Michael S.
Publication year - 2005
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2005.tb00091.x
Subject(s) - leverage (statistics) , bankruptcy , risk aversion (psychology) , business , debt , investment (military) , microeconomics , systematic risk , investment decisions , actuarial science , economics , finance , financial economics , expected utility hypothesis , behavioral economics , machine learning , politics , computer science , political science , law
We create a dynamic model in which a self‐interested, risk‐averse manager makes corporate investment decisions at a levered firm with characteristics typical of public US firms. We examine the magnitude of distortions in those decisions when a new project changes firm risk and find expected changes in the values of future tax shields and bankruptcy costs to be important factors. We evaluate the extent to which these distortions vary with firm leverage, debt duration, project size, managerial risk aversion, managerial non‐firm wealth, and the structure of management compensation packages