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June 20, 2003
Antonio E. Bernardo
Information, agency, and incentives∗
Capital budgeting in multi-division ﬁrms:
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ni yap desab-ecnamrofrep level-mrﬁ dna level-noisivid fo ecnatropmi evitaler eht dna ,noisivid rehto eht ni seitinutroppo tnemtsevni fo ytilauq eht ot noisivid eno ni tnemtsevni fo ytivitisnes eht tuoba snoitciderp lanoitces-ssorc evired osla eW .)tseb-tsrﬁ ot evitaler( secruoser eziliturednu sreganam dna latipac ni stsevnired -nu yllareneg mrﬁ ehT .ytilauq rehgih si tcej orp rieht taht troper sreganam nehw yralas rewol a dna yap ecnamrofrep retaerg sreﬀo tcartnoc noitasnepmoc lairega -nam lamitpo ehT .secruoser ,yltsoc yletavirp tub ,gnicnahne-eulav ot ssecca )elba -ﬁirevnu( )ii( dna ytilauq tcej orp tuoba noitamrofni )elbaﬁirevnu( )i( edivorp nac ohw reganam lartuen-ksir a yb nur hcae )snoisivid( stcej orp tnemtsevni owt htiw mrﬁ a ni noitasnepmoc laireganam dna noitacolla latipac lamitpo enimaxe eW
The long-term health of a ﬁrm is determined by the quality of its investments. In a typical ﬁrm, capital is allocated to investment projects based on reports by division managers who have access to private information about project quality. The eventual success of any project may also require the input and cooperation of other managers who control access to valuable resources within the ﬁrm. The ﬁrm, however, may not 1
be able to either independently verify the managers’ reports or monitor the actions of managers to ensure that they are deploying and sharing their resources appropriately. Thus, to secure its long-term health, the ﬁrm must provide incentives to encourage truthful information and the appropriate utilization of managerial resources. In this paper, we present a simple model to illustrate these information and incentive problems in a multi-division ﬁrm. Speciﬁcally, we consider a ﬁrm with unlimited access to capital and two investment projects. The optimal amount of capital to allocate to each project depends on its quality which is unknown to the ﬁrm’s headquarters. For each project, however, the ﬁrm can hire a risk-neutral manager with private information which is useful for assessing the quality of both projects. Once hired, each manager reports her information (not necessarily truthfully) to headquarters which then allocates capital according to the reports. The veracity of the reports is assumed to be non-veriﬁable and non-contractible. Once capital is allocated, project cash ﬂows can be enhanced by either or both managers by deploying resources under their control. The use of these resources is assumed to be privately costly, non-veriﬁable, and non-contractible.
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dna stsoc eht dnatsrednu pleh ot sretrauqdaeh fo elor evitcudorp eht ledom ylticilpxe )7991( nietS dna )4991( nietS dna ,nietsfrahcS ,rentreG .ssecorp noitcudorp eht ot elbasnepsidni si sretrauqdaeh s’mrﬁ eht os ,ton od sreganam noisivid tub latipac ot ssecca sah mrﬁ eht emussa osla eW .mrﬁ eht fo epocs eht nevig sa ekat ew ,rehtar ;repap siht ni mrﬁ eht fo seiradnuob eht ezylana ylticilpxe ton od ew ,revewoH .mrﬁ emas eht nihtiw tsixe snoisivid eht nosaer eht eb llew yrev yam snoisivid rehto ni elbaliava secruoser eht no...
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