Investment, Compensation, and Risk Aversion [Archive.org URL]

In this article, Erwan Morellec of the University of Rochester models the effect of managerial risk aversion on manager’s decision making. He shows that risk-averse mangers are more likely to invest early. In his words: “to speed up investment, leading to significant erosion of the value of the option to invest.” Why is this? Again quoting: “By investing, the manager transforms a real option into a productive asset. Because the volatility of a call option is always greater than the volatility of the underlying asset, investing reduces idiosyncratic risk and thus improves managerial utility.” GREAT article! [FinanceProfessor.com annotation]

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