The main purpose of this paper is to investigate how organizational slack is created and how it affects a firm’s performance. To address these questions, we construct three equations: managerial incentive function, organizational slack formation function and performance function, and we apply 3SLS simultaneously to these functions by using the data sets of about 2000 Japanese firms from the years 2001 and 2006. From the empirical analysis of these Japanese firms, we obtain the following results: a firm’s performance declines as organizational slack increases; organizational slack decreases as managerial incentive is strengthened and a firm’s annual change rate of revenues increases; and managerial incentive is affected by corporate governance structure but not by performance.
[JEL Classification]: L22, L25, M21
[Key Words]: Organizational slack, Performance, Managerial incentive, Corporate governance, Cost frontier function