Empire building by corporate managers: The corporation as a savings instrument

The paper reports two findings. First, independent corporate managers operating under a linear incentive contract tend to overinvest, thus failing to maximize the wealth of corporate owners. This provides a formal proof of Jensen's influential proposal that under separation of ownership and control investment will be inefficient. Second, the empire-building motive is shown to be related to the degree of uncertainty, the structure of the managerial compensation scheme, and the degree of risk aversion and preference for prudence. The model provides an integration of the traditional neoclassical theory of investment under uncertainty and the theory of investment under separation of ownership and control introduced by the theory of corporate finance. (C) 2000 Elsevier Science B.V. All rights reserved.