Agency, firm growth, and managerial turnover

We study the relation between firm growth and managerial incentive provision under moral hazard when a long-lived firm is operated by a sequence of managers. In our model, firms replace their managers not only upon poor performance to provide incentives, but also when outside managers are at a comparative advantage to lead the firm through a new growth phase. We show how the optimal contract can be implemented with a system of deferred compensation credit and bonuses, along with dismissal and severance policies. Firms with better investment prospects have higher managerial turnover and rely on more front-loaded compensation schemes. Growth-induced turnover can result in positive severance if the principal needs to incentivize the manager to truthfully report the arrival of a growth opportunity. Realized firm growth depends jointly on the exogenous arrival of growth opportunities and the severity of the moral hazard problem. We also find a new component of agency costs due to the spillover effect of the tenure of the incumbent manager onto the present value of future managers’ compensation.