Capital Budgeting and Managerial Compensation: Incentive and Retention Effects

2003 ◽  
Vol 78 (1) ◽  
pp. 71-93 ◽  
Author(s):  
Sunil Dutta
Keyword(s):  
Private Information ◽  
Investment Decision ◽  
Investment Project ◽  
Capital Budgeting ◽  
Managerial Compensation ◽  
Capital Investments ◽  
Compensation Contracts ◽  
Hurdle Rate ◽  
Hurdle Rates ◽  
Manager Incentives

This paper considers an agency model in which a firm's manager receives private information about an investment project. The manager has unique skills that are essential for implementing the project, and he can pursue the project inside the firm or as an outside venture on his own. The firm's owner thus faces a potential managerial retention problem, where the severity of the retention problem depends on the project's outside viability. My analysis shows that if the managerial retention problem is not too severe, the owner can delegate the investment decision to the manager and use a residua-lincome-based bonus contract to give the manager incentives to work hard and make appropriate investment decisions. If the retention problem is severe, however, then the owner must use an option-based compensation contract to retain the manager and provide him with appropriate incentives. I also establish that as the managerial retention problem becomes more severe, the owner reduces the rate of return, or hurdle rate, required to approve the investment project. These results predict that new-economy firms, in which managerial expertise is critical and yet mobile, are more likely to (1) include stock options in their managers' compensation contracts, and (2) apply lower hurdle rates for approving capital investments.

Delegated Investment Decisions and Private Benefits of Control

2003 ◽  
Vol 78 (4) ◽  
pp. 909-930 ◽  
Author(s):  
Tim Baldenius
Keyword(s):  
Empirical Studies ◽  
Investment Project ◽  
Capital Budgeting ◽  
Rate Of Return ◽  
Residual Income ◽  
Compensation Contracts ◽  
Charge Rate ◽  
Optimal Capital ◽  
Hurdle Rates ◽  
Budgeting Process

This paper studies the capital budgeting process in a setting where a manager is privately informed about the profitability of an investment project and enjoys nonpecuniary benefits of control (“empire benefits”). I characterize the optimal required rate of return and show that a delegation scheme with residual income-based compensation can replicate the benchmark performance achieved under centralization. The main result of the paper is that the optimal capital charge rate for computing residual income always exceeds the required rate of return as a result of empire benefits. This highlights the necessity for future empirical studies on capital budgeting to distinguish between alternative forms of hurdle rates. Contrary to conventional wisdom, I further show that if compensation contracts are derived endogenously, then the shareholders will ultimately benefit from the manager's empire benefits even under asymmetric information.

Hurdle Rates and Project Development Efforts

2009 ◽  
Vol 84 (2) ◽  
pp. 405-432 ◽  
Author(s):  
Sunil Dutta ◽  
Qintao Fan
Keyword(s):  
Investment Project ◽  
Capital Budgeting ◽  
Optimal Choice ◽  
Development Effort ◽  
Project Development ◽  
Investment Opportunities ◽  
Investment Returns ◽  
Hurdle Rate ◽  
Hurdle Rates

ABSTRACT: We examine the optimal choice of hurdle rates in a capital budgeting setting in which a manager receives superior information regarding the profitability of an investment project. Unlike the prior capital budgeting literature that treats the distribution of investment returns as exogenous, we consider a scenario in which the manager can engage in upfront project development activities to improve the quality of investment opportunity. To motivate the project development effort while ensuring truthful information flow, the optimal hurdle rate is always lower than what it would be if the manager's project development effort were directly observable. We show that the optimal hurdle rate can even be below the firm's cost of capital under plausible circumstances. We also examine how the optimal hurdle rate varies with the ex ante quality of the firm's investment opportunities, and find that optimal hurdle rates will be higher in firms whose investment opportunities are relatively good or relatively poor than in firms with investment opportunities of intermediate quality.

scholarly journals EXPLANATION OF THE BENEFIT OF THE INVESTMENT PROJECT ON THE CASH BASIS / IZRAŽAVANJE KORISTI INVESTICIONOG PROJEKTA NA GOTOVINSKOJ OSNOVI

2019 ◽  
Vol 16 (2) ◽  
Author(s):  
Dijana Kremenović
Keyword(s):  
Growth And Development ◽  
Investment Decision ◽  
Investment Decisions ◽  
Investment Project ◽  
Capital Budgeting ◽  
Investment Activity ◽  
Investment Projects ◽  
Investment Process ◽  
Additional Value ◽  
Cash Basis

Decisions about the choice of investment projects can significantly affect the destiny of the company, its competitive position in the market, market participation, the direction of further technological development, and even the survival of the company. The aim of this paper is, in the conditions of the current economic reality, to point out the significance of the choice of methods of expressing the benefit of an investment project. In this sense, we have explained in detail all currently applicable methods for assessing the viability of investment projects on a cash basis, comparing the good and bad sides of all the methods presented. In this connection, we especially pointed out the importance of the time value of money. The decision to apply the capital budgeting process, certainly, is the decision of the company itself. However, the outcome of investment activity is borne by a wider circle of consumers, which should be a sufficient reason to encourage education and the application of current methods in this area. If you want to realistically look at the investment process and evaluate the justification of an investment project, it is necessary to identify and analyse the effects of exploitation of a particular investment. In order to ensure the realization of the company’s basic strategic goals and thus ensure its growth and development, it is necessary to make decisions in which the company will focus its investment activities on this investment projects whose effects will ensure the highest return on investment. This work deals with the complex issues of making adequate investment decisions using a method for assessing the viability of investment projects on a cash basis. Bearing in mind the significance of investment activity, we can conclude that for the purpose of making a good investment decision, it is necessary to realistically look at the entire investment process and assess the justification of the implementation of the investment project. In this sense, we identify, measure and quantify the overall effects of the realization of a particular investment. Capital budgeting for the purpose of making an investment decision today is a generally accepted concept in developed economies. There is no doubt that there are many disagreements regarding the choice of the methods of assessing the viability of investment investments, and then the selection of criteria within a certain method. However, it is quite certain that the rich experience of developed countries undoubtedly points to the need for capital budgeting, investment project management, with particular emphasis on the use of discounted methods for assessing the viability of investment investment and respecting both economic and non-economic effects. Implicit benefits that the application of capital budgeting brings to the overall growth and development of the company, in terms of reducing uncertainty in making investment decisions, easier ranking of investment projects, exact measurement of expected benefits, transparency of investment activity criteria, attracting investors and ultimately creating additional value and greater degree of realization of strategic company goals.With this work, we pointed out the fact that capital budgeting is crucial in the process of making an investment decision and in that way has influenced enterprises to seriously deal with the choice of the method of estimating the profitability of investment projects that will surely result in additional value for the company.

scholarly journals CAPITAL BUDGETING ANALYSIS OF INVESTMENT PROJECT FEASIBILITY IN PT INTEGRA INDOCABINET TBK

2019 ◽  
Vol 1 (2) ◽  
pp. 251-256
Author(s):  
Adetia Wardani ◽  
Ani Wulandari
Keyword(s):  
Decision Making ◽  
Investment Decisions ◽  
Investment Project ◽  
Secondary Data ◽  
Capital Budgeting ◽  
Payback Period ◽  
Property Companies ◽  
Hurdle Rate

This research is a case study conducted in one of the property companies in Sidoarjo, East Java, namely PT Integra Indocabinet Tbk ,. Based on secondary data, PT Integra Indocabinet has increased sales and profits from 2014 - 2018. Therefore, the owners want to expand their expansion by adding new factory facilities so they can get more optimal profits and can increase exports abroad. The research aims to provide assistance in the form of suggestions for decision making between feasible or not worthy of the investment carried out. Based on the calculation, obtained an NPV value of 195,510,594,699 ≥ 0 which means it is feasible to run, an IRR of 22%> hurdle rate (10%) which means it is feasible to run; Payback Period is 4 years 3 months> 5 years which means it is feasible to be implemented; The Profitability Index is 1.98> 0, which means it's worth running. The results of the analysis show that using Capital Budgeting techniques can be seen that investment decisions for expansion are feasible.

Evaluating investment projects: The hurdle rate

2000 ◽  
Vol 2 (4) ◽  
pp. 295-303
Author(s):  
Hsaio‐Yun Chen ◽  
Charles Ward
Keyword(s):  
Real Options ◽  
Cost Of Capital ◽  
Capital Budgeting ◽  
Capital Projects ◽  
Rational Use ◽  
Investment Projects ◽  
Hurdle Rate ◽  
Hurdle Rates ◽  
The Cost

A previous paper in this journal discussed how to estimate the appropriate rate that should be used to evaluate investment projects. In this paper, the same theme is extended to discuss why projects might attract hurdle rates that are higher than the cost of capital. The answer involves discussion of the topic of real options, which may provide a rigorous explanation of how companies can value flexibility in capital budgeting. This paper discusses the gap between the hurdle rate and the cost of capital and explores possible explanations for the rational use of additional barriers before accepting capital projects.

scholarly journals Escalation of Commitment: Supporting Role from Accountants

2021 ◽  
Vol 4 (2) ◽  
pp. 87
Author(s):  
Agil Novriansa ◽  
Ahmad Subeki ◽  
Aryanto Aryanto
Keyword(s):  
Decision Making ◽  
Undergraduate Students ◽  
Investment Decision ◽  
Investment Project ◽  
Capital Budgeting ◽  
Sunk Costs ◽  
Financial Accounting ◽  
Escalation Of Commitment ◽  
Sunk Cost ◽  
Investment Decision Making

Previous research has mostly examined the phenomenon of escalation of commitment in the context of decision making by managers in an investment project. However, in the capital budgeting process, before making investment decisions managers tend to consider information produced by accountants. This study examines the phenomenon of escalation of commitment using the perspective of supporting role of accountants as the party that provides information for investment decision making by managers, especially in the presence of sunk costs. This study uses a laboratory experimental method. The sample in this study are 156 undergraduate students majoring in Accounting who had passed Financial Accounting and Management Accounting courses. Based on the results of the independent sample t-test, it shows that accountants who experienced sunk cost conditions tend to provide reports that directed managers towards escalation of commitment behavior compared to accountants who do not experience sunk cost conditions. The presence of sunk cost makes accountants have better mind frame to get the possibility of profit compared with a definite loss so that the decisions they make tend to provide reports that lead to the escalation of commitment behavior.

scholarly journals FINANCIAL MANAGEMENT ELEMENTS SPECIFIC TO INVESTMENTS APPLICABLE IN EDUCATIONAL SYSTEMS

2020 ◽  
Author(s):  
Daniela Alice Luta (Manolescu) ◽  
◽  
Adrian Ioana ◽  
Daniela Tufeanu ◽  
Daniela Ionela Juganaru ◽  
...  
Keyword(s):  
Financial Management ◽  
Investment Decision ◽  
Investment Project ◽  
Educational Systems ◽  
Capital Investments ◽  
Financial Flows ◽  
Long Run ◽  
Starting Point ◽  
The Future ◽  
High Degree

Our starting point is the definition and classification of investments, both financial and accounting. Thus, in a financial sense, an investment represents the change of an existing and available amount of money, with the hope of obtaining a higher but probable income in the future. In the accounting sense, an investment is the allocation of an amount available for the purchase of an asset, which will determine the future financial flows of income and expenses. Investments can be classified into two categories: domestic investments - consist of the allocation of capital for the purchase of machines, equipment, constructions, licenses, patents, etc. Their purpose can be to reduce costs, increase production, improve quality, increase market share, etc.; foreign investments - consist of capital investments in shares in other companies. They are also called financial investments and aim to increase the value of the company and diversify sources of income. We also analyze in this article the investment decision. The investment decision is the most important financial decision which a manager has to make. An investment usually involves allocating large sums of money in the long run, with a relatively high degree of risk. We also present and analyze both the stages of establishing an investment decision and the methods of evaluating an investment project. The article also presents management elements regarding the investment recovery term; discounted net value method, investment risk assessment.

scholarly journals Capital Budgeting Analysis Of Investment Project Feasibility in PT Integra Indocabinet TBK

2019 ◽  
Vol 2 (1) ◽  
Author(s):  
Adetia Wardani ◽  
Wahyudiono Wahyudiono
Keyword(s):  
Decision Making ◽  
Investment Decisions ◽  
Investment Project ◽  
Secondary Data ◽  
Capital Budgeting ◽  
Payback Period ◽  
Property Companies ◽  
Hurdle Rate

This research is a case study conducted in one of the property companies in Sidoarjo, East Java, namely PT Integra Indocabinet Tbk ,. Based on secondary data, PT Integra Indocabinet has increased sales and profits from 2014 - 2018. Therefore, the owners want to expand their expansion by adding new factory facilities so they can get more optimal profits and can increase exports abroad. The research aims to provide assistance in the form of suggestions for decision making between feasible or not worthy of the investment carried out. Based on the calculation, obtained an NPV value of 195,510,594,699 ≥ 0 which means it is feasible to run, an IRR of 22%> hurdle rate (10%) which means it is feasible to run; Payback Period is 4 years 3 months> 5 years which means it is feasible to be implemented; The Profitability Index is 1.98> 0, which means it's worth running. The results of the analysis show that using Capital Budgeting techniques can be seen that investment decisions for expansion are feasible.

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