When q theory meets large losses risks and agency conflicts

We incorporate large losses risks into the DeMarzo et al.(2012) model of dynamic agency and the q theory of investment. The large losses risks induce losses costs and losses arising from agency conflicts during the large losses prevention process. Both of them reduce firm's value, distort investment policy and generate a deeper wedge between the marginal and average q. In addition, we study the implementation of the contract to enhance the practical utility of our model. The agent optimally manages the firm's cash flow and treats the cash reservation and credit line as the firm's financial slack, and hedges the productivity shocks and large losses shocks via futures and insurance contracts, respectively.