Optimal Dynamic Capital Budgeting

Andrey Malenko

The Review of Economic Studies, 2019, vol. 86, issue 4, 1747-1778

Abstract: I study optimal design of a dynamic capital allocation process in an organization in which the division manager with empire-building preferences privately observes the arrival and properties of investment projects, and headquarters can audit projects at a cost. Under certain conditions, a budgeting mechanism with threshold separation of financing is optimal. Headquarters: (1) allocate a spending account to the manager and replenish it over time; (2) set a threshold, such that projects below it are financed from the account, while projects above are financed fully by headquarters upon an audit. Further analysis studies when co-financing of projects is optimal and how the size of the account depends on past performance of projects.

Keywords: Principal agent; Capital budgeting; Internal capital markets; Repeated interactions (search for similar items in EconPapers)
JEL-codes: D82 D86 G31 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (18)

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Persistent link: https://EconPapers.repec.org/RePEc:oup:restud:v:86:y:2019:i:4:p:1747-1778.

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