SMU SOE Seminar (Apr 19, 2017): Internal Financing, Managerial Compensation and Multiple Tasks

We study the choice between internal and external financing without restricting the set of possible compensation schemes and capital allocation rules. Managers can dedicate effort either to increase the short-term profitability of the firm, thus generating greater immediate cash-flow, or to improve the long-term perspectives. When both types of effort are observable low return firms end up using internal funds and focusing on short-term outcomes, while high return firms use external capital markets. When effort to boost short-term cash flow is observable, while effort to boost long-term profitability is not, non-monotonic policies become possible.

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