Abstract
Individual’s time preferences may be influenced by a variety of factors such as economic conditions. In this paper, we consider the time inconsistent preferences triggered by the switches in firm’s profitability states and apply them to the model of dynamic agency and to the q theory of investment. And we investigate effects of triggered time-inconsistent preferences on the optimal contract between investors and manager, Tobin’s q and firm investment. We find that time-inconsistent preferences increase the value loss of investors in both states. Owning to the manager’s time-inconsistent preferences, the contract should make more adjustments for the manager’s continuation payoff conditional on a jump from one state to the alternative state. Meanwhile, the firm prefers paying the manager with cash in advance due to the triggered time-inconsistent preferences. It also shows that the manager’s time inconsistency induces underinvestment and reduces the sensitivity of investment, firm’s average q and marginal q in both states.
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