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Firm Value and Managerial Incentives: A Stochastic Frontier Approach

Michel A. Habib and Alexander Ljungqvist
The Journal of Business
Vol. 78, No. 6 (November 2005), pp. 2053-2094
DOI: 10.1086/497040
Stable URL:
Page Count: 42
Subjects: Business Finance
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Firm Value and Managerial Incentives: A Stochastic Frontier Approach
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We provide a direct estimate of the magnitude of agency costs in publicly held corporations. We compute an explicit performance benchmark that compares a firm's actual Tobin's Q to the Q* of a hypothetical value‐maximizing firm having the same inputs and characteristics as the original firm. The Q of the average sample firm is around 16% below its Q*, equivalent to a $1,432 million reduction in its potential market value. We relate the shortfall to the incentives provided CEOs. Boards appear to grant CEOs too few shares and too many options that are insufficiently sensitive to firm risk.

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