Multistage Capital Budgeting for Shared Investments

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. This paper was accepted by Mary Barth, accounting.

The role of the controller in strategic capital investment projects: bridging the gap of multiple topoi

“…The tools and techniques which managers use to plan and make effective investment decisions have been discussed extensively. For example, stagegate processes in development projects (e.g., Van Oorschot et al 2010;Behrens et al 2014), multistage capital budgeting (Johnson et al 2013) and option-based stochastic valuation modeling (Kauffman et al 2015) have been addressed. However, other researchers claim that the rational perspective alone is unlikely to provide a full understanding of strategic capital budgeting processes.…”

Incentivizing Irreversible Investment

“…Our paper contributes to the growing literature in accounting that uses real options models to study questions in incentive provision and product costing and pricing decisions (e.g., Arya and Glover 2001;Pfeiffer and Schneider 2007;Caskey and Hughes 2012;Johnson, Pfeiffer, and Schneider 2013;Reichelstein and Rohlfing-Bastian 2015;Baldenius, Nezlobin, andVaysman 2016, Johnson andPfeiffer 2016;Johnson, Pfeiffer, and Schneider 2017;Reichelstein and Sahoo 2018). 7 Perhaps, the paper closest to ours from this stream of literature is Baldenius et al (2016), which shows that goal congruence is not attainable in a model where the firm's manager is responsible for timing a single binary investment decision.…”

Organizational Goals, Outcomes, and the Assessment of Performance: Reconceptualizing Success in Management Studies

“…For instance, prior studies have examined the effects of goal setting on strategic decisions, such as cost savings decisions (Gaba and Joseph, 2013; Savva et al., 2019), the enactment of search breadth and depth strategies (Hahn et al., 2019), the enactment of effective and timely decisions (Gary et al., 2017; Kownatzki et al., 2013), as well as the search for private equity (Shafi et al., 2020) or crowdfunding (Belavina et al., 2020) financing. Moreover, this organizational‐level research has also examined organizational decisions, such as how organizations set up routines to facilitate goals’ achievement (Dittrich and Seidl, 2018), to display a positive organizational climate (Parke and Seo, 2017), to increase collaboration among employees (Lee and Puranam, 2017), as well as how to structure R&D alliances (multilateral vs bilateral) (Li et al., 2012), how to enact the right form of organizational control (Mazmanian and Beckman, 2018), and how to induce goal‐congruent investment decisions by divisional managers (Johnson et al., 2013). Thus, we acknowledge a set of studies that account for this direct link between organizational goal setting and how it translates into specific organizational outcomes.…”

“…Johnson et al. (2013) propose a model of optimal capital budgeting for shared investment decisions through the design of goal‐congruent performance metrics. Caldwell et al.…”