Multi-Stage Capital Budgeting with Delayed Consumption of Slack

Management Science, 2012

30 Pages Posted: 2 Jul 2012

See all articles by Stanley Baiman

Stanley Baiman

University of Pennsylvania - Accounting Department

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department

Richard E. Saouma

David Eccles School of Business; MSU

Date Written: July 2, 2012

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 NPV projects at Stage 1 (capital rationing), while 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.

Keywords: Resource Allocation, Capital Budgeting, Rationing, Adverse Section, Dynamic Rents

Suggested Citation

Baiman, Stanley and Heinle, Mirko Stanislav and Saouma, Richard E., Multi-Stage Capital Budgeting with Delayed Consumption of Slack (July 2, 2012). Management Science, 2012. Available at SSRN: https://ssrn.com/abstract=2097939

Stanley Baiman

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States
215-898-6782 (Phone)
215-573-2054 (Fax)

Mirko Stanislav Heinle

University of Pennsylvania - Accounting Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

Richard E. Saouma (Contact Author)

David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

MSU ( email )

East Lansing, MI 48824-1121
United States

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