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Controlling Investment Decisions: Depreciation- and Capital Charges

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  • Sunil Dutta

  • Stefan Reichelstein

Abstract

This paper examines a multiperiod principal-agent model in which a divisional manager has superior information regarding the profitability of an investment project available to his division. The manager also contributes to the periodic operating cash flows of his division through personally costly effort. We demonstrate that it is optimal for the principal to delegate the investment decision and to base the manager's compensation on the residual income performance measure. Our analysis points to a class of depreciation rules and to a particular capital charge rate which together ensure that a profitable (unprofitable) project makes a positive (negative) contribution to residual income in every period. As a consequence, the compensation parameters for each period can be chosen freely so as to address the moral hazard problems without impacting the manager's investment incentives.

Suggested Citation

  • Sunil Dutta & Stefan Reichelstein, 2002. "Controlling Investment Decisions: Depreciation- and Capital Charges," Review of Accounting Studies, Springer, vol. 7(2), pages 253-281, June.
    • Handle: RePEc:spr:reaccs:v:7:y:2002:i:2:d:10.1023_a:1020238405769
    DOI: 10.1023/A:1020238405769
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    References listed on IDEAS

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    2. Stefan Reichelstein, 1997. "Investment Decisions and Managerial Performance Evaluation," Review of Accounting Studies, Springer, vol. 2(2), pages 157-180, June.
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    Cited by:

    1. Sudhakar Balachandran & Partha Mohanram, 2012. "Using residual income to refine the relationship between earnings growth and stock returns," Review of Accounting Studies, Springer, vol. 17(1), pages 134-165, March.
    2. Sunil Dutta & Stefan Reichelstein, 2010. "Decentralized capacity management and internal pricing," Review of Accounting Studies, Springer, vol. 15(3), pages 442-478, September.
    3. Madhav V. Rajan, 2003. "Discussion of “Performance Evaluation and Corporate Income Taxes in a Sequential Delegation Setting”," Review of Accounting Studies, Springer, vol. 8(2), pages 311-319, June.
    4. James A. Ohlson, 2002. "Discussion of “Residual Income and Value-Creation: The Missing Link”," Review of Accounting Studies, Springer, vol. 7(2), pages 247-251, June.
    5. Sunil Dutta & Qintao Fan, 2025. "Innovation incentives and competition for corporate resources," Review of Accounting Studies, Springer, vol. 30(3), pages 2635-2672, September.
    6. Alwine Mohnen & Moshe Bareket, 2007. "Performance measurement for investment decisions under capital constraints," Review of Accounting Studies, Springer, vol. 12(1), pages 1-22, March.
    7. Tim Baldenius & Amir Ziv, 2003. "Performance Evaluation and Corporate Income Taxes in a Sequential Delegation Setting," Review of Accounting Studies, Springer, vol. 8(2), pages 283-309, June.
    8. Iván Marinovic, 2014. "Discussion of “equilibrium earnings management and managerial compensation in a multiperiod agency setting”," Review of Accounting Studies, Springer, vol. 19(3), pages 1078-1085, September.
    9. Alexander Nezlobin & Stefan Reichelstein & Yanruo Wang, 2015. "Managerial performance evaluation for capacity investments," Review of Accounting Studies, Springer, vol. 20(1), pages 283-318, March.
    10. Jonathan Glover, 2002. "Discussion of: “Controlling Investment Decisions: Depreciation and Capital Charges”," Review of Accounting Studies, Springer, vol. 7(2), pages 283-287, June.

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