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Optimal Dynamic Capital Budgeting

Andrey Malenko

MIT Sloan School of Management

November 7, 2013

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: (i) allocate a spending account to the manager and replenish it over time; (ii) 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, how the size and replenishment rate of the account depend on headquarters' commitment power, and when using multiple category-specific spending accounts is optimal.

Number of Pages in PDF File: 57

Keywords: principal-agent, capital budgeting, internal capital markets, repeated interactions

JEL Classification: G31, D82, D86

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Date posted: November 19, 2010 ; Last revised: November 8, 2013

Suggested Citation

Malenko, Andrey, Optimal Dynamic Capital Budgeting (November 7, 2013). Available at SSRN: http://ssrn.com/abstract=1710884 or http://dx.doi.org/10.2139/ssrn.1710884

Contact Information

Andrey Malenko (Contact Author)
MIT Sloan School of Management ( email )
100 Main Street
Cambridge, MA 02142
United States
617-225-9301 (Phone)
HOME PAGE: http://www.mit.edu/~amalenko
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