Multistage Capital Budgeting for Shared Investments

Multistage Capital Budgeting for Shared Investments

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Article ID: iaor20132441
Volume: 59
Issue: 5
Start Page Number: 1213
End Page Number: 1228
Publication Date: May 2013
Journal: Management Science
Authors: , ,
Keywords: accounting, capital budgeting
Abstract:

This paper studies the performance of delegated decision‐making schemes in a two‐stage, multidivision capital budgeting problem for a shared investment with an inherent abandonment option. Applying both robust goal congruence and sequential adverse selection frameworks, we show that the optimal capital budgeting mechanism entails a capital charge rate above the firm's cost of capital in the first stage but below the cost of capital in the second stage. Further, the first‐stage asset cost‐sharing rule depends only on the relative divisional growth profiles, and equal cost sharing can be optimal even when the divisions receive significantly different benefits from the shared investment project. In the presence of an adverse selection problem, all agency costs are incorporated into the second‐stage budgeting mechanism, leaving the first‐stage capital charge rate and asset‐sharing rule unaffected even though the agency problem induces capital rationing at both stages.

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