Multistage Capital Budgeting with Delayed Consumption of Slack

Stanley Baiman (), Mirko S. Heinle () and Richard Saouma
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Stanley Baiman: University of Bocconi, 20141 Milan, Italy; and The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104
Mirko S. Heinle: The Wharton School, University of Pennsylvania, Philadelphia, Pennsylvania 19104

Management Science, 2013, vol. 59, issue 4, 869-881

Abstract: Capital budgeting frequently involves multiple stages at which firms can continue or abandon ongoing projects. In this paper, we study a project requiring two stages of investment. Failure to fund Stage 1 of the investment precludes investment in Stage 2, whereas failure to fund Stage 2 results in early termination. In contrast to the existing literature, we assume that the firm can limit the manager's informational rents with the early termination of the project. In this setting, we find that the firm optimally commits to a capital allocation scheme whereby it forgoes positive net present value (NPV) projects at Stage 1 (capital rationing), whereas at Stage 2, depending on the manager's previous report, it sometimes implements projects with a negative continuation NPV but in other situations forgoes implementing projects with positive continuation NPVs. This paper was accepted by Mary Barth, accounting.

Keywords: accounting; capital budgeting; resource allocation; multistaged financing; abandonment options; milestone-contingent investments (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (5)

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