Long-Term Capital Budgeting and Incentive Mechanism

50 Pages Posted: 27 Oct 2015 Last revised: 2 Oct 2017

See all articles by Buqu Gao

Buqu Gao

Boston University

Tak-Yuen Wong

National Tsing Hua University - Department of Quantitative Finance

Date Written: October 2, 2017


We characterize the optimal dynamic mechanism for capital budgeting and managerial compensation. The division manager privately observes the project productivity at each point in time as well as an initial signal that governs the productivity evolution. We show that the optimal allocation can be implemented by a simple mechanism with a one-time report of the initial signal. In the simple mechanism, the headquarters delegates the investment decisions to the manager and finances the capital expenditure by tying the budget to a linear compensation scheme. The project growth and the power of incentives depend on how the initial signal affects the future types.

Keywords: Capital Budgeting, Dynamic Mechanism Design, Managerial Compensations, Adverse Selection, Moral Hazard, Internal Capital Market

JEL Classification: D82, G31

Suggested Citation

Gao, Buqu and Wong, Tak-Yuen, Long-Term Capital Budgeting and Incentive Mechanism (October 2, 2017). Available at SSRN: https://ssrn.com/abstract=2679661 or http://dx.doi.org/10.2139/ssrn.2679661

Buqu Gao

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States

Tak-Yuen Wong (Contact Author)

National Tsing Hua University - Department of Quantitative Finance ( email )

101, Section 2, Kuang-Fu Road
Hsinchu, Taiwan 300

HOME PAGE: http://https://sites.google.com/site/etywong110/

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