Firm Investment and Stakeholder Choices: A Top-Down Theory of Capital Budgeting

51 Pages Posted: 3 Dec 2011 Last revised: 14 Mar 2012

See all articles by Andres Almazan

Andres Almazan

University of Texas at Austin - Department of Finance

Zhaohui Chen

University of Virginia - McIntire School of Commerce

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: November 12, 2011

Abstract

This paper considers the optimal design of capital budgeting rules when the firm’s capital budgeting process involves the interaction of top executives, with private information and stakeholders (e.g., employees) whose motivation and efforts affect the likelihood of the firm’s success. In this setting, the decisions of top executives affect stakeholders’ inferences about firms’ prospects and as a result, influence their actions. Specifically, higher levels of investment expenditures indicate that a firm has promising prospects and induce stakeholders to take actions that contribute to the firm’s success. Within this framework we examine the role of commonly observed capital budgeting rules which not only play their traditional allocative role but also affect how private information is transmitted from the top down. As we show, the optimal capital budgeting mechanism is consistent with a number of commonly observed investment distortions such as capital rationing, investment rigidities, overinvestment, and inflated discount rates.

Keywords: Capital expenditures, budgeting rules, mechanism design

Suggested Citation

Almazan, Andres and Chen, Zhaohui and Titman, Sheridan, Firm Investment and Stakeholder Choices: A Top-Down Theory of Capital Budgeting (November 12, 2011). AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1967292 or http://dx.doi.org/10.2139/ssrn.1967292

Andres Almazan (Contact Author)

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-471-4368 (Phone)
512-471-5073 (Fax)

HOME PAGE: http://www.mccombs.utexas.edu/dept/finance/faculty/profiles/index.asp?addTarget=4

Zhaohui Chen

University of Virginia - McIntire School of Commerce ( email )

P.O. Box 400173
Charlottesville, VA 22904-4173
United States
434-243-1188 (Phone)

Sheridan Titman

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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