Capital Budgeting in Multidivision Firms: Information, Agency, and Incentives |
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Authors: | Bernardo, Antonio E. Cai, Hongbin Luo, Jiang |
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Abstract: | We examine optimal capital allocation and managerial compensationin a firm with two investment projects (divisions) each runby a risk-neutral manager who can provide (i) (unverifiable)information about project quality and (ii) (unverifiable) accessto value-enhancing, but privately costly resources. The optimalmanagerial compensation contract offers greater performancepay and a lower salary when managers report that their projectis higher quality. The firm generally underinvests in capitaland managers underutilize resources (relative to first-best).We also derive cross-sectional predictions about the sensitivityof investment in one division to the quality of investment opportunitiesin the other division, and the relative importance of division-leveland firm-level performance-based pay in managerial compensationcontracts. |
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