intertemporal cost allocation and managerial investment incentives a theory explaining the use of economic value added as a performance measure this paper provides a formal analysis of how managerial investment incentives are affected by alternative allocation rules when managerial compensation is based on accounting measures of income that include allocations for investment expenditures the main result is that there exists a unique allocation rule that always induces the manager to choose the efficient investment level the income measure created by this allocation rule is usually referred to as residual income or economic value added

multistage capital budgeting with delayed consumption of slack capital budgeting frequently involves multiple stages at which firms can continue or abandon ongoing projects in this paper we study a project requiring two stages of investment failure to fund stage 1 of the investment precludes investment in stage 2 whereas failure to fund stage 2 results in early termination in contrast to the existing literature we assume that the firm can limit the manager s informational rents with the early termination of the project in this setting we find that the firm optimally commits to a capital allocation scheme whereby it forgoes positive net present value npv projects at stage 1 capital rationing whereas at stage 2 depending on the manager s previous report it sometimes implements projects with a negative continuation npv but in other situations forgoes implementing projects with positive continuation npvs this paper was accepted by mary barth accounting

a complete characterization of optimal growth paths in an aggregated model with a non concave production function the convexity of technology has played a crucial role in economic analyses of optimal one sector growth problems for example two of the key results on the traditional model of ramsey 1928 that have relied on the convexity of the technology are that optimal intertemporal growth involves moving monotonically towards a unique steady state as in cass 1965 koopmans 1965 and that the value function is a concave differentiable function of the initial capital stock as in benveniste and scheinkman 1979

prospect theory mental accounting and differences in aggregated and segregated evaluation of lottery portfolios if individuals have to evaluate a sequence of lotteries their judgment is influenced by the presentation mode experimental studies have found significantly higher acceptance rates for a sequence of lotteries if the overall distribution was displayed instead of the set of lotteries itself mental accounting and loss aversion provide an easy and intuitive explanation for this phenomenon in this paper we offer an explanation that incorporates further evaluation concepts of prospect theory our formal analysis of the difference in aggregated and segregated portfolio evaluation demonstrates that the higher attractiveness of the aggregated presentation mode is not a general phenomenon as suggested in the literature but depends on specific parameters of the lotteries the theoretical findings are supported by an experimental study in contrast to the existing evidence and in line with our theoretical results we find for specific types of lotteries an even lower acceptance rate if the overall distribution is displayed

a two sector model of endogenous growth with leisure in this paper we analyze a class of endogenous growth models with physical and human capital and with three altematives uses of time unqualified leisure work and education in contrast to some other related models we find that even in the absence of technological extemalities there could be multiple balanced paths we provide a characterization of the qualitative behavior of consumption leisure work and education over those balanced paths and study their transitional dynamics

an experiment on risk taking and evaluation periods does the period over which individuals evaluate outcomes influence their investment in risky assets results from this study show that the more frequently returns are evaluated the more risk averse investors will be the results are in line with the behavioral hypothesis of myopic loss aversion which assumes that people are myopic in evaluating outcomes over time and are more sensitive to losses than to gains the results have relevance for the equity premium puzzle and also for the marketing strategies of fund managers

experimental tests of the separation theorem and the capital asset pricing model a computer controlled multistage portfolio selection task was devised to test experimentally basic assumptions underlying the separation theorem and the capital asset pricing model although most of the subjects diversified among the three risky assets the introduction of a riskless asset did not have the effect predicted by the separation theorem nor were the subjects affected by systematic changes in the variance covariance matrix of the risky returns however performance improved as the reward was increased tenfold the capital asset pricing model capm proposed by william sharpe 1964 john lintner 1965 and jan mossin 1966 has been the predominant normative as well as positive theory for determining assets returns and prices in financial markets the capm has a wide range of implications for various financial issues including the allocation of risky assets price predictions performance indices and market efficiency tests as well as tools for corporate finance decisions such as capital structure costs of financial sources and prices of new issues during the last decade numerous theoretical studies have examined and extended the capm a most recent development is the

investment tax incentives prices and the supply of capital goods using data on the prices of capital goods this paper shows that much of the benefit of investment tax incentives does not go to investing firms but rather to capital suppliers through higher prices the reduction in the cost of capital from a 10 percent investment tax credit increases equipment prices 3 5 7 0 percent this lasts several years and is largest for assets with large order backlogs low import competition or with a large fraction of buyers able to use investment subsidies capital goods workers wages rise too instrumental variables estimates of the short run supply elasticity are around 1 and can explain the traditionally small estimates of investment demand elasticities in absolute value the demand elasticity implied here exceeds 1

the effects of risk aversion on production decisions in decentralized organizations this paper presents a principal agent model in which subsequent to contracting the risk averse agent becomes informed about the production process communication of the agent s information is always valuable the optimal contract given this information asymmetry is characterized by less production and a larger risk premium than when information is symmetric leading to an efficiency loss comparative statics show that the loss in expected production increases as the agent becomes more risk averse

goal congruence analysis in multi division organizations with shared resources based on data envelopment analysis abstract in multi division organizations goal congruence between different divisions and top management is critical to the success of management in this paper drawing upon a nonparametric framework to model production technology we derive a necessary and sufficient condition for a firm with multiple divisions to be goal congruent and then extend it to a goal congruence testing measure which coincides with a data envelopment analysis dea model the goal congruence measure not only shows empirically whether the firm is goal congruent or not but also provides a measurement for the degree of goal incongruence to be goal congruent resources shared among divisions are suggested to be allocated so that the conditions for an optimizable operation are satisfied in addition goal congruent firms are verified to be cost efficient all findings in this research are examined and illustrated with a dataset of 20 bank branches with shared resources for service and sales divisions

option value to waiting created by a control problem we study a principal agent model in which there is an option to defer a capital project approval decision a control incentive problem makes the option to wait valuable when it would not have been valuable otherwise deferring the project approval decision has both a cost and a benefit the cost of waiting is that the agent s uncertainty regarding future project cost realizations cannot be exploited however by delaying the first project s approval decision the principal can condition its approval on the agent s cost report of the second project such conditioning can be valuable in the provision of incentives because of a diversification effect

sometimes less is more the influence of information aggregation on investment decisions abstract we study the effect of information aggregation on individual investors risk taking behavior in two experiments each having three different treatments subjects in the control group were given hypothetical returns for both the risk free and the risky asset subjects in the account group were also given information about returns separately for each of the two assets however this information was scaled according to a subject s chosen investment amount subjects in the portfolio group could observe returns on a portfolio level which constitutes the highest level of information aggregation in our study results show that a higher degree of information aggregation results in greater risk taking increased risk taking is associated with a lower risk perception and a more accurate estimation of the probability of a loss furthermore reporting aggregated returns might lead investors to evaluate the aggregated outcome relative to a different reference point the overall portfolio instead of the amount invested in risky assets which makes them less likely to experience a loss and therefore increases the willingness to invest in the risky asset thus aggregating information seems to reduce mental accounting namely having one account for risky and one account for risk free investments ex post our findings show that the portfolio group also makes consistent subsequent allocation decisions and shows a lower dissatisfaction with outcomes in the loss domain the results were consistent across both experiments despite the use of different subject pools and investment amounts

non convexities in continuous time investment theory that non convex preferences or technologies cause problems for economic theory is well known in recent years there have been numerous contributions to the nonconvexity problem in the context of models with a finite dimensional commodity space in the capital theory context non convexities have received explicit treatment in a few papers in two distinguishable ways the problem is cast either in a discrete time framework aoki 1971 rothschild 1971 or in a continuous time framework in which there are implicitly unbounded economies of scale in investment the latter formulation leads to jumps in the state variable or lumpy investment the standard problem treated is one of decreasing costs in the installation of new capacity contributions include chenery 1952 dixit mirrlees and stern 1975 hartwick 1976 manne 1967 srinivasan 1967 starrett 1978 and weitzman 1970 these types of analysis unfortunately ignore some of the most interesting problems associated with non convexities in investment theory in a discrete time framework the important distinction between stocks and flows is blurred while the capacity installation problem by admitting unbounded scale economies excludes the smoothing of state variables that follows by allowing for eventually increasing costs of adjustment in this paper we undertake a systematic examination of non convexities or sometimes non concavities in the context of a classic problem in continuous time investment theory the optimal accumulation of capital by a firm maximizing its present value over an infinite horizon while the results obtained are specific to this particular model we feel that they can be qualitatively extended to any capital theory problem which can be cast in a continuous time optimal control theory framework there are various sorts of non2 convexities which can arise in these problems first there can be either stock or flow non convexities that is non convexities which are introduced into the net benefit function the measure of the flow of benefits at each moment through changes in the capital stock state variable on the one hand or changes in the flow of investment control variable on the other if the benefit and transition functions are not concave in both these variables then necessary conditions are no longer sufficient for optimality and conventional marginal analysis fails non convexities can also be introduced into the value functional which has a stock dimension in order to examine these different sorts of non convexity problems we shall now present the basic economic problem a firm is faced with the problem of maximizing the present value of discounted cash flow over an infinite horizon hence it chooses an investment programme i t to maximize 00

equipment prices human capital and economic growth abstract this paper presents a multisectoral model of economic growth in which endogenous technological progress is embodied in new equipment capital the difference in the intensity of use of human capital across sectors creates aggregate dynamic non convexities and hence the model may generate multiple balanced growth paths under standard parameter values our model can explain the observed correlations found for a pool of countries between investment rates in equipment capital and income growth on the one hand and between the rate of decline in equipment prices and income growth on the other the model is then used to study the effectiveness of two public policies that have been widely implemented to promote economic growth an equipment investment tax credit and a tax incentive to human capital accumulation our results indicate that both policies have positive effects on equipment investment and on long run growth

long run implications of investment specific technological change an attempt is made to disentangle its effects from the more traditional hicksneutral form of technological progress the balanced growth path for the model is characterized and calibrated to u s national income and product account nipa data the quantitative analysis suggests that investment specific technological change accounts for the major part of growth jel e13 030 041 047

dominant strategy implementation of bayesian incentive compatible allocation rules abstract a large literature on incentive mechanisms represents incentive constraints by the requirement that truthful reporting be a bayesian equilibrium this paper identifies mechanism design problems for which there is no loss in replacing bayesian incentive compatibility by the stronger requirement of dominant strategies we identify contexts where it is possible to change the transfer payments of an optimal bayesian mechanism so as to create dominant strategies and yet leave every participant s expected utility unchanged we also address the issue of multiple equilibria and unique implementation contexts where these results apply include auctions bilateral bargaining procurement contracting and intrafirm resource allocation

multistage capital budgeting for shared investments this paper studies the performance of delegated decision making schemes in a two stage multidivision capital budgeting problem for a shared investment with an inherent abandonment option applying both robust goal congruence and sequential adverse selection frameworks we show that the optimal capital budgeting mechanism entails a capital charge rate above the firm s cost of capital in the first stage but below the cost of capital in the second stage further the first stage asset cost sharing rule depends only on the relative divisional growth profiles and equal cost sharing can be optimal even when the divisions receive significantly different benefits from the shared investment project in the presence of an adverse selection problem all agency costs are incorporated into the second stage budgeting mechanism leaving the first stage capital charge rate and asset sharing rule unaffected even though the agency problem induces capital rationing at both stages this paper was accepted by mary barth ac

a theory of socialistic internal capital markets abstract we develop a model of a two division firm in which the strong division has on average higher quality investment opportunities than the weak division we show that in the presence of agency and information problems optimal effort incentives are less powerful and thus managerial effort is lower in the strong division this leads the firm to bias its project selection policy against the strong division the selection bias is more severe when there is a larger spread in the average quality of investment opportunities between the two divisions

residual income based compensation plans for controlling investment decisions under sequential private information earlier literature has pointed to the effectiveness of residual income type measures based on particular accrual accounting rules such as the relative benefit allocation rule these performance metrics have been shown to generate desirable managerial incentives when investment decisions are delegated this paper further attests to the robustness of these measures by extending the result to a sequential adverse selection model with an inherent real option an option to abandon in other words as long as the residual income measures are judiciously constructed neither private information nor the requirement to selectively exercise an option derails their use in this setting

capital rationing and organizational slack in capital budgeting this paper reconciles three stylized facts about capital budgeting in firms and shows that they are tied to the presence of asymmetric information among the several members of the firm each with his or her own objectives and decisions the facts of interest are 1 the existence of organizational slack 2 the rationing of resources within organizations 3 the stated cut off rate for accepting capital projects in firms is often greater than the market rate of interest organizational slack is defined as the excess of resources allocated over the minimum necessary to accomplish the tasks assigned resource rationing is defined as the under allocation of resources i e an increase in the amount allocated would generate revenues in excess of its costs rationing and slack are both manifestations of ex post inefficiencies an lp model is used to show that these inefficiencies can occur in ex ante efficient organizational designs when asymmetric information is present the optimal allocation policy involves a hurdle rate criterion in which the hurdle rate is strictly in excess of the cost of capital thus inducing rationing in some states of the world typically resources are optimally allocated such that slack exists in other states the optimal allocation policy trades off these two inefficiencies