Dynamic Compensation and Investment with Limited Commitment

Abstract

In this dissertation I study the role of limited commitment in dynamic models. In the first part, I consider firms that face uncertainty shocks in a principal-agent setting but have only limited ability to commit to long-term contracts. Limited commitment firms expedite payments to their managers when uncertainty is high, a finding that helps to explain the puzzling large bonuses observed during the recent financial crisis. In the second part, I examine a dynamic investment model where firms invest in a risky asset but cannot hedge the risk of their investment because they lack the ability to commit to future repayments of debt. Once firms have access to exogenous supply of risk free assets they may, on the aggregate level, invest more in the risky asset because risk free technology allows them to grow richer in equilibrium. This result helps to explain the asset price booms in emerging countries when those countries experience substantial capital outflow.