Executive Effort and Selection of Risky Projects

This article examines the incentives of executives to adopt risky projects. The agency problem considered is that of motivating the executive to expend effort to generate information about the profitability of projects and to select the "best" project conditional upon the information that his effort generates. We show that the executive and the principal will not always agree regarding which project is best. We provide conditions under which this conflict of interest leads (from the principal's perspective) to either an underinvestment or an overinvestment in risky projects.