Agency Contracts, Noncommitment Timing Strategies and Real Options

Abstract

Given that an owner lacks the ability to commit to his or her timing decisions under a manager's hidden action, we consider the optimal design of the contract and the owner's optimal timing decisions. Using a real options approach, we show that, compared with the full commitment case, a higher (lower)-quality project is launched later than (at the same time as) the first-best case, whereas the replacement of the manager is (is not necessarily) made later if the hidden-action problem is severe enough (is not severe enough). Severance pay may serve to minimize the compensation for the manager's loss of corporate control.