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Moral Hazard in Corporate Investment and the Disciplinary Role of Voluntary Capital Rationing

Author

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  • Guochang Zhang

    (Department of Accounting, Hong Kong University of Science & Technology, Clear Water Bay, Kowloon, Hong Kong)

Abstract

This paper compares three capital-budgeting rules, the NPV rule, a high hurdle rate and capital rationing, and explains why some firms may voluntarily impose capital rationing. Under both capital rationing and a high hurdle, a restrictive investment criterion is used to control managerial shirking. However, implementation of these budgeting rules requires a mechanism to prevent the firm from expanding the investment scale ex post. Capital rationing, in the form of a predetermined, fixed budget, differs from the high-hurdle-rate rule in that the former requires the firm to overcome the cost of raising additional capital before making further investment.

Suggested Citation

  • Guochang Zhang, 1997. "Moral Hazard in Corporate Investment and the Disciplinary Role of Voluntary Capital Rationing," Management Science, INFORMS, vol. 43(6), pages 737-750, June.
  • Handle: RePEc:inm:ormnsc:v:43:y:1997:i:6:p:737-750
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    File URL: http://dx.doi.org/10.1287/mnsc.43.6.737
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    Citations

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    Cited by:

    1. Atal, Vidya & Bar, Talia & Gordon, Sidartha, 2016. "Project selection: Commitment and competition," Games and Economic Behavior, Elsevier, vol. 96(C), pages 30-48.
    2. Bernardo, Antonio E. & Cai, Hongbin & Luo, Jiang, 2001. "Capital budgeting and compensation with asymmetric information and moral hazard," Journal of Financial Economics, Elsevier, vol. 61(3), pages 311-344, September.
    3. Talia Bar & Sidartha Gordon, 2014. "Optimal Project Selection Mechanisms," American Economic Journal: Microeconomics, American Economic Association, vol. 6(3), pages 227-255, August.
    4. Roper, Andrew H. & Ruckes, Martin E., 2012. "Intertemporal capital budgeting," Journal of Banking & Finance, Elsevier, vol. 36(9), pages 2543-2551.
    5. Yang Dong & Kefeng Xu & Yi Xu & Xiang Wan, 2013. "Quality Assurance Contracts in a Multi-Level Supply Chain," Working Papers 0206mss, College of Business, University of Texas at San Antonio.
    6. Les Coleman & Krishnan Maheswaran & Sean Pinder, 2010. "Narratives in managers’ corporate finance decisions," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 50(3), pages 605-633, September.
    7. Bernardo, Antonio E. & Cai, Hongbin & Luo, Jiang, 2002. "Capital Budgeting in Multi-Division Firms: Information, Agency, and Incentives," University of California at Los Angeles, Anderson Graduate School of Management qt0779b20v, Anderson Graduate School of Management, UCLA.
    8. Kim, Doyoung, 2006. "Capital budgeting for new projects: On the role of auditing in information acquisition," Journal of Accounting and Economics, Elsevier, vol. 41(3), pages 257-270, September.
    9. Arya kumar srustidhar Chand & Amit R k, 2015. "Capital rationing under perfect information," Economics Bulletin, AccessEcon, vol. 35(2), pages 878-884.
    10. Brian Kulik & Michael O’Fallon & Manjula Salimath, 2008. "Do Competitive Environments Lead to the Rise and Spread of Unethical Behavior? Parallels from Enron," Journal of Business Ethics, Springer, vol. 83(4), pages 703-723, December.
    11. Vidya Atal & Talia Bar & Sidartha Gordon, 2013. "Search, Project Adoption and the Fear of Commitment," Sciences Po publications 2013-12, Sciences Po.
    12. Brüggen, Alexander & Luft, Joan, 2011. "Capital rationing, competition, and misrepresentation in budget forecasts," Accounting, Organizations and Society, Elsevier, vol. 36(7), pages 399-411.
    13. Yan Dong & Kefeng Xu & Yi Xu & Xiang Wan, 2016. "Quality Management in Multi-Level Supply Chains with Outsourced Manufacturing," Production and Operations Management, Production and Operations Management Society, vol. 25(2), pages 290-305, February.

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