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Selection among Mutually Exclusive Investments with Managerial Private Information and Moral Hazard

Listed author(s):
  • Rick Antle

    (Yale School of Management)

  • Peter Bogetoft

    (Royal Agricultural University)

  • Andrew W. Stark

    (Manchester Business School)

We investigate the problem of selecting capital investments in an organizational context with asymmetric information. In a principal-agent model where a manager (agent) has superior information about the investment costs of n available mutually exclusive projects, we develop the owner´s (principal´s) optimal investment and compensation policies subject to the constraints created by the manager´s strategic behavior. The optimal policies take a simple form, and are defined by a handicapping scheme involving n cost targets, one for each of the possible projects. The optimal investment policy does not select the project with maximal, positive net present value (NPV). To limit the manager´s informational rents, projects with positive NPV may be forgone. Also, the project with maximal NPV is not always selected. To save on incentive costs, there will be tendency by to favour projects with less variation in costs. Furthermore, when the available projects are asymmetric ex ante, it may nevertheless be optimal to use an asymmetric policy.

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Paper provided by University of Copenhagen. Department of Economics. Centre for Industrial Economics in its series CIE Discussion Papers with number 1997-06.

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Length: 24 pages
Date of creation: Feb 1997
Handle: RePEc:kud:kuieci:1997-06
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