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Intertemporal Cost Allocation and Investment Decisions

  • William P. Rogerson
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    This paper considers the profit-maximization problem of a firm that must make sunk investments in long-lived assets to produce output. It is shown that if per-period accounting income is calculated using a simple and natural allocation rule for investment, called the relative replacement cost (RRC) rule, under a broad range of plausible circumstances, the firm can choose the fully optimal sequence of investments over time simply by choosing a level of investment each period in order to maximize the next period's accounting income. Furthermore, in a model in which shareholders delegate the investment decision to a better-informed manager, it is shown that if accounting income based on the RRC allocation rule is used as a performance measure for the manager, robust incentives are created for the manager to choose the profit-maximizing sequence of investments, regardless of the manager's own personal discount rate or other aspects of the manager's personal preferences. (c) 2008 by The University of Chicago. All rights reserved..

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    File URL: http://www.journals.uchicago.edu/doi/pdf/10.1086/591909
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    Article provided by University of Chicago Press in its journal Journal of Political Economy.

    Volume (Year): 116 (2008)
    Issue (Month): 5 (October)
    Pages: 931-950

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    Handle: RePEc:ucp:jpolec:v:116:y:2008:i:5:p:931-950
    Contact details of provider: Web page: http://www.journals.uchicago.edu/JPE/

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