This paper investigates the relation between the form of compensation and the manager's decision horizon. It finds that while all-cash contracts induce managers to underinvest in the long term, all-stock contracts induce overinvestment in the long term. It shows that compensation contracts consisting of both cash and restricted stock can produce efficient investment, thereby providing a rationale for the existence of both cash and stock incentive schemes in executive compensation packages. This explains why the adoption of either type of incentive scheme results in a positive stock price reaction. In addition, the paper derives the following testable hypotheses: i) the proportion of the stock compensation is decreasing in the precision of the manager's ability and increasing in the precision of the firm's cash flows; ii) firms compensate their managers with proportionately more stock in profitable years and proportionately more cash in leaner years; and iii) the greater the growth opportunities, the higher the proportion of stock compensation.

In a world of asymmetric information in which only the insiders know the quality of the firm, it is claimed that debt, even if it is risky, is more advantageous than outside equity because issuance of debt is less attractive to inferior firms. The advantage to debt arises from the fact that it can keep unprofitable firms out of the market, thus improving the average quality of firms in the market. This advantage exists even if the firms cannot be perfectly sorted in the signaling equilibrium.

ABSTRACT Of late, concern has been expressed that American managers tend to make decisions that yield short‐term gains at the expense of the long‐term interests of the shareholders. In this paper, we have attempted to investigate managerial incentives for such decisions. We find that, when the manager has private information regarding his or her decisions, there exist situations wherein the manager has incentives to make decisions which yield short‐term profits but are not in the stockholders best interests. This incentive for suboptimal decisions arises because the manager, by taking decisions yielding short‐term profits, hopes to enhance his reputation earlier, thus boosting his wages. We also find that this incentive is inversely related to her experience, the duration of her contract, and the risk of the firm.

Three major motives have been suggested for takeovers: synergy, agency, and hubris. Existing empirical evidence is unable to clearly distinguish among these motives probably due to the simultaneous existence of all three in any sample of takeovers. This paper suggests a way of distinguishing among these competing hypotheses by looking at the correlation between target and total gains. It is argued that this correlation should be positive if synergy is the motive, negative if agency is the motive, and zero if hubris is the motive. The empirical results show that synergy is the primary motive in takeovers with positive total gains even though the evidence is consistent with the simultaneous existence of hubris in this sample. It is also found that agency is the primary motive in takeovers with negative total gains.

[The role of the medium of exchange in competition among bidders and its effect on returns to stockholders in corporate takeovers are investigated. Consistent with recent empirical evidence, our model shows that stockholders of both acquiring and target firms obtain higher returns when a takeover is financed with cash rather than equity, and that returns to target shareholders increase with competition. The model predicts that the fraction of synergy captured by the target decreases with the level of synergy. Finally, it is shown that, as competition increases, the cash component of the offer as well as the proportion of cash offered increases.]