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Managerial incentives for capacity investment decisions

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  • Christian Lohmann

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Abstract

In a setting where the owner of a company delegates the authority to make overlapping capacity investments to a manager, the decision on such investments depends on how the decision-maker perceives the marginal cost of capacity. This covers the cost for one additional unit of capacity made available for only one period of time, although expenditures for capacity investments are a common cost of capacity that can be used over multiple periods. If the manager’s performance measure is residual income, the level of the marginal cost of capacity and the associated investment incentives depend on the applied depreciation schedule and the manager’s time preferences. We examine the direction of the effect of several depreciation schedules on the marginal cost of capacity that the manager perceives and analyze the extent to which this cost is distorted. Our analysis shows that a performance measure based on residual income, combined with several practically relevant depreciation schedules, creates the desired investment incentives for the manager, because differently structured depreciation schedules have a relatively small effect on the level of the marginal cost of capacity. We also examine how partial direct expensing can increase the objective congruence of residual income as a managerial performance measure if the straight-line depreciation schedule or the annuity depreciation schedule is used. Copyright Springer-Verlag Berlin Heidelberg 2015

Suggested Citation

  • Christian Lohmann, 2015. "Managerial incentives for capacity investment decisions," Journal of Management Control: Zeitschrift für Planung und Unternehmenssteuerung, Springer, vol. 26(1), pages 27-49, April.
  • Handle: RePEc:spr:jmgtco:v:26:y:2015:i:1:p:27-49
    DOI: 10.1007/s00187-015-0202-5
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    File URL: http://hdl.handle.net/10.1007/s00187-015-0202-5
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    References listed on IDEAS

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    1. repec:bla:joares:v:38:y:2000:i:2:p:243-269 is not listed on IDEAS
    2. Rogerson William P, 2011. "On the Relationship Between Historic Cost, Forward Looking Cost and Long Run Marginal Cost," Review of Network Economics, De Gruyter, vol. 10(2), pages 1-31, June.
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    6. Rogerson, William P, 1997. "Intertemporal Cost Allocation and Managerial Investment Incentives: A Theory Explaining the Use of Economic Value Added as a Performance Measure," Journal of Political Economy, University of Chicago Press, vol. 105(4), pages 770-795, August.
    7. Madhav V. Rajan & Stefan Reichelstein, 2009. "Depreciation Rules and the Relation between Marginal and Historical Cost," Journal of Accounting Research, Wiley Blackwell, vol. 47(3), pages 823-865, June.
    8. Tim Baldenius & Stefan Reichelstein, 2005. "Incentives for Efficient Inventory Management: The Role of Historical Cost," Management Science, INFORMS, vol. 51(7), pages 1032-1045, July.
    9. Thomas Pfeiffer & Georg Schneider, 2007. "Residual Income-Based Compensation Plans for Controlling Investment Decisions Under Sequential Private Information," Management Science, INFORMS, vol. 53(3), pages 495-507, March.
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    Cited by:

    1. Deng, Binbin, 2016. "A Simple Model of Managerial Incentives and Portfolio-Investment Decision," MPRA Paper 79959, University Library of Munich, Germany.

    More about this item

    Keywords

    Capacity investment; Depreciation schedules; Investment incentives; Marginal cost of capacity; C63; M41; M52;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting
    • M52 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Personnel Economics - - - Compensation and Compensation Methods and Their Effects

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