Duopolistic Investment Opportunities under Agency Risk: Designing Contracts for Optimal Investment Decisions David Cardoso § and Paulo J. Pereira ‡∗ . § School of Economics, University of Porto. ‡ CEF.UP and School of Economics, University of Porto. December 2011 Abstract 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. Keywords : Real options; Investment timing; Agency; Optimal contracting. * Faculdade de Economia da Universidade do Porto. Rua Dr. Roberto Frias, 4200-464 Porto (Portugal). E-mail: pjpereira@fep.up.pt. Phone: +351 225 571 225. Fax: +351 225 505 050