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Capital budgeting and managerial empire building

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  • Katrin Weiskirchner-Merten

Abstract

I examine how a company's headquarters use an empire-building manager's report about decision-relevant private information to make capital budgeting decisions and compensate the manager. To this end, I construct a model comprising the headquarters (principal) and the manager (agent), who reports on the investment project's expected profitability. I identify the optimal investment sizes and compensation payments, where the headquarters trade off managerial information rents – arising from empire-building benefits inducing the manager to favour overinvestment – for investment efficiency. The headquarters counteract the manager's desire for overinvestment with investment distortions in the form of underinvestment (or overinvestment) for a high (or low) expected profitability. Due to these distortions, the expected compensation is not monotone in the level of empire-building benefits. Unlike previous capital budgeting studies, in this study, I show that managerial empire-building benefits can multi-directionally affect companies' optimal capital budgeting decisions and related compensation schemes.

Suggested Citation

  • Katrin Weiskirchner-Merten, 2023. "Capital budgeting and managerial empire building," Accounting and Business Research, Taylor & Francis Journals, vol. 53(4), pages 416-438, June.
    • Handle: RePEc:taf:acctbr:v:53:y:2023:i:4:p:416-438
    DOI: 10.1080/00014788.2021.2021502
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