Duopolistic Investment Opportunities under Agency Risk: Designing Contracts for Optimal Investment Decisions

Real options theory frequently assumes that investment decisions are directly taken by the owners or that, if there is a manager, he is fully aligned with them. However, empirical literature demonstrates that managers may reveal misaligned interests, which may deteriorate the value of the firm, consequently having a major impact on value maximizing decisions, namely, on the optimal timing to invest. This paper provides a contribute to the existing real options by dropping this assumption in the non-exclusive option case, specifically providing a duopolistic leader-follower framework where an agency problem between the owners of the option and their respective managers, is embodied and solved by an optimal labor contract scheme that aims to eliminate inadequate actions from the managers. In this model, both firms shareholders need not to follow the future evolution of project value drivers in order to guarantee optimal behavior. An analytical application is provided, being shown that even small deviations from the optimal compensation scheme may lead to highly sub-optimal decisions. JEL classification: G31; D82.