Controlling investment decisions : depreciation and capital charges

Reichelstein, Stefan ; Dutta, Sunil

Document Type: Working paper
Year of publication: 2001
The title of a journal, publication series: Working Papers
Volume: 1722
Place of publication: Stanford, CA
Publishing house: Stanford Graduate School of Business
ISSN: 1869-0483 , 1869-0491
Publication language: English
Institution: Business School > Stiftungsprofessur für ABWL (Reichelstein 2018-)
Subject: 330 Economics
Abstract: There has been considerable debate in recent years about alternative managerial performance measures and their ability to align the interests of owners and managers. It appears that the residual income measure, i.e., accounting income minus an interest charge on the capital used by a division, has received particular attention in this debate. To implement residual income as a performance measure, firms have to choose capital charge rates for individual divisions as well as applicable accounting rules, e.g., schedules for depreciating the assets acquired by a division. There seems to be general agreement that for internal performance measurement firms should not view themselves as constrained by the accounting rules used for external financial reporting. This paper examines a multiperiod principal-agent model in which a divisional manager has superior information regarding the profitability of an investment project available to his division. In addition, the manager's effort is assumed to increase the periodic cash flows of his division. We find that under certain conditions it is optimal for the principal to delegate the investment decision to the manager and to base managerial compensation on residual income. Our agency model speaks to the literature on alternative implementations of the residual income performance measure by identifying depreciation rules and capital charge rates that are consistent with optimal incentive contracting.

Dieser Datensatz wurde nicht während einer Tätigkeit an der Universität Mannheim veröffentlicht, dies ist eine Externe Publikation.

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