Abstract This article studies dynamic compensation and risk management under cash-flow volatility shocks. The optimal contract depends critically on firms’ ability to make good on promised future payments to managers. When volatility is low, firms with full commitment ability implement high pay–performance sensitivity to motivate effort from managers, and they impose large penalties on the arrival of volatility shocks to incentivize prudent risk management. In contrast, firms with limited commitment may allow excessive risk taking in exchange for low pay–performance sensitivity. When volatility becomes high, firms with full commitment defer compensation more, whereas firms with limited commitment must expedite payments.

We explore theoretically and empirically the relationship between firm productivity and liquidity management in the presence of financial frictions. We build a dynamic investment model and show that, counter to basic economic intuition, more productive firms could demand less capital assets and hold more liquid assets compared to less productive firms when financing costs are sufficiently high. We empirically test this prediction using a comprehensive dataset of Chinese manufacturers and find that more productive firms indeed hold less capital and more cash. We do not, however, observe this for US manufacturers. Our study suggests a larger capital misallocation problem in markets with significant financing frictions than previously documented.

We study the optimal dynamic contract that provides incentives for an agent (e.g., SPAC sponsor, VC general partner, CTO) to exploit investment opportunities/targets that arrive randomly over time via a costly search process. The agent is privy to the arrival as well as to the quality of the target and can take advantage of this for rent extraction during the search process and the ensuing production. The optimal contract provides the agent with incentives for timely and truthful reporting via a time-varying threshold for investment and an internal charge for the time spent on search. In the equilibrium, as time elapses, the charge becomes progressively higher while the investment threshold is progressively lower, resulting in overinvestment at a time-varying degree. Our model generates empirically testable predictions regarding investments (such as M&As, hedge fund activism, VC investing, SPACs, and internal innovations), linking the degree of overinvestment to observable firm and industry characteristics. • Optimal dynamic contract for the search and use of investment opportunities/targets. • Adverse selection arises regarding the arrival of targets and their quality. • Optimal contract involves a progressively declining hurdle for investments. • The investments hurdle is always below the first-best, implying overinvestment. • Our results shed light on internal innovation, M&A, SPACs, VC and HFA investments.

How do firms modify CEO risk-incentive compensation in response to increased foreign competition? Theoretically we show the answer is ambiguous: increased competition can result in firms either increasing or decreasing the CEO's risk-taking incentives. Empirically using a quasi-natural experiment, tariff cuts resulting from important trade deals, we find evidence that in response to increases in foreign competition firms adjust CEO risk-incentive compensation downwards – a result that is more pronounced for firms with less risk-averse CEOs. These findings suggest that more intense foreign competition results in managers voluntarily taking on more risk, and firms therefore reduce the convexity in managers' compensation.

We investigate optimal project management in a setting plagued by an indefinite number of setbacks that are discovered en route to project completion. The contractor can cover up delays in progress due to shirking either by making false claims of setbacks or by postponing the reports of real ones. The sponsor optimally induces work and honest reporting via a soft deadline and a reward for completion that specifies a bonus for early delivery. Late‐stage setbacks trigger randomization between minimally feasible project extension and (inefficient) cancellation. Because extensions may be granted repeatedly, arbitrarily large overruns in schedule and budget are possible after which the project may still be canceled.

ABSTRACT This paper studies the value of a firm’s internal information when the firm faces an adverse selection problem arising from unobservable managerial abilities. Although more precise information allows the firm to make ex post more efficient investment decisions, noisier information has an ex ante screening effect that allows the firm to attract on-average better managers. The tradeoff between more effective screening of managers and more informed investment implies a nonmonotonic relationship between firm value and information quality. A marginal improvement in information quality does not necessarily lead to an overall improvement in firm value. JEL Classifications: M41; D82; G34.