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Capital budgeting and managerial empire building

Capital budgeting and managerial empire building I examine how a company's headquarters use an empire-building manager's report about decision-relevant private information to make capital budgeting decisions and compensate the manager. To this end, I construct a model comprising the headquarters (principal) and the manager (agent), who reports on the investment project's expected profitability. I identify the optimal investment sizes and compensation payments, where the headquarters trade off managerial information rents – arising from empire-building benefits inducing the manager to favour overinvestment – for investment efficiency. The headquarters counteract the manager's desire for overinvestment with investment distortions in the form of underinvestment (or overinvestment) for a high (or low) expected profitability. Due to these distortions, the expected compensation is not monotone in the level of empire-building benefits. Unlike previous capital budgeting studies, in this study, I show that managerial empire-building benefits can multi-directionally affect companies' optimal capital budgeting decisions and related compensation schemes. http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png Accounting and Business Research Taylor & Francis

Capital budgeting and managerial empire building

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Publisher
Taylor & Francis
Copyright
© 2022 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group
ISSN
2159-4260
eISSN
0001-4788
DOI
10.1080/00014788.2021.2021502
Publisher site
See Article on Publisher Site

Abstract

I examine how a company's headquarters use an empire-building manager's report about decision-relevant private information to make capital budgeting decisions and compensate the manager. To this end, I construct a model comprising the headquarters (principal) and the manager (agent), who reports on the investment project's expected profitability. I identify the optimal investment sizes and compensation payments, where the headquarters trade off managerial information rents – arising from empire-building benefits inducing the manager to favour overinvestment – for investment efficiency. The headquarters counteract the manager's desire for overinvestment with investment distortions in the form of underinvestment (or overinvestment) for a high (or low) expected profitability. Due to these distortions, the expected compensation is not monotone in the level of empire-building benefits. Unlike previous capital budgeting studies, in this study, I show that managerial empire-building benefits can multi-directionally affect companies' optimal capital budgeting decisions and related compensation schemes.

Journal

Accounting and Business Research – Taylor & Francis

Published: Jun 7, 2023

Keywords: Empire building; capital budgeting; compensation; overinvestment; underinvestment; H26; H87; M42

References

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