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Optimal Dynamic Capital Budgeting

Author

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  • Andrey Malenko

Abstract

I study optimal design of a dynamic capital allocation process in an organization in which the division manager with empire-building preferences privately observes the arrival and properties of investment projects, and headquarters can audit projects at a cost. Under certain conditions, a budgeting mechanism with threshold separation of financing is optimal. Headquarters: (1) allocate a spending account to the manager and replenish it over time; (2) set a threshold, such that projects below it are financed from the account, while projects above are financed fully by headquarters upon an audit. Further analysis studies when co-financing of projects is optimal and how the size of the account depends on past performance of projects.

Suggested Citation

  • Andrey Malenko, 2019. "Optimal Dynamic Capital Budgeting," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 86(4), pages 1747-1778.
    • Handle: RePEc:oup:restud:v:86:y:2019:i:4:p:1747-1778.
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    File URL: http://hdl.handle.net/10.1093/restud/rdy043
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    Citations

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    Cited by:

    1. Xu, Su Xiu, 2021. "Overexploitation Risk in “Green Mountains and Clear Water”," Ecological Economics, Elsevier, vol. 179(C).
    2. Feng, Felix Zhiyu & Westerfield, Mark M., 2021. "Dynamic resource allocation with hidden volatility," Journal of Financial Economics, Elsevier, vol. 140(2), pages 560-581.
    3. Kakhbod, Ali & Loginova, Uliana, 2023. "When does introducing verifiable communication choices improve welfare?," Journal of Economic Behavior & Organization, Elsevier, vol. 210(C), pages 139-162.
    4. Christoph Siemroth, 2022. "Dezemberfieber senken: Vermeidung von verschwenderischen Jahresendausgaben [Reducing “Dezemberfieber”: Wasteful Year-End Spending and a Solution]," Wirtschaftsdienst, Springer;ZBW - Leibniz Information Centre for Economics, vol. 102(6), pages 461-464, June.
    5. Lipnowski, Elliot & Ramos, João, 2020. "Repeated delegation," Journal of Economic Theory, Elsevier, vol. 188(C).
    6. Hoffmann, Florian & Pfeil, Sebastian, 2021. "Dynamic multitasking and managerial investment incentives," Journal of Financial Economics, Elsevier, vol. 142(2), pages 954-974.
    7. Chen, Yi, 2022. "Dynamic delegation with a persistent state," Theoretical Economics, Econometric Society, vol. 17(4), November.
    8. Rantakari, Heikki, 2023. "How to reward honesty?," Journal of Economic Behavior & Organization, Elsevier, vol. 207(C), pages 129-145.
    9. Mayer, Simon, 2022. "Financing breakthroughs under failure risk," Journal of Financial Economics, Elsevier, vol. 144(3), pages 807-848.
    10. Min Dai & Xavier Giroud & Wei Jiang & Neng Wang, 2020. "A q Theory of Internal Capital Markets," NBER Working Papers 27931, National Bureau of Economic Research, Inc.
    11. Guo, Yingni & Hörner, Johannes, 2020. "Dynamic Allocation without Money," TSE Working Papers 20-1133, Toulouse School of Economics (TSE).
    12. Yingni Guo & Johannes Hörner, 2021. "Dynamic Allocation without Money," Working Papers hal-03187506, HAL.
    13. Siemroth, Christoph, 2022. "Ending Wasteful Year-End Spending: On Optimal Budget Rules in Organizations," Economics Discussion Papers 32231, University of Essex, Department of Economics.
    14. Achim, Peter & Knoepfle, Jan, 0. "Relational enforcement," Theoretical Economics, Econometric Society.
    15. Gryglewicz, Sebastian & Mayer, Simon & Morellec, Erwan, 2020. "Agency conflicts and short- versus long-termism in corporate policies," Journal of Financial Economics, Elsevier, vol. 136(3), pages 718-742.

    More about this item

    Keywords

    Principal agent; Capital budgeting; Internal capital markets; Repeated interactions;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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