Premium
Innovation, endogenous overinvestment, and incentive pay
Author(s) -
Inderst Roman,
Klein Manuel
Publication year - 2007
Publication title -
the rand journal of economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 3.687
H-Index - 108
eISSN - 1756-2171
pISSN - 0741-6261
DOI - 10.1111/j.0741-6261.2007.00117.x
Subject(s) - incentive , investment (military) , business , industrial organization , microeconomics , investment decisions , key (lock) , capital budgeting , process (computing) , economics , behavioral economics , ecology , politics , project appraisal , political science , computer science , law , biology , operating system
We analyze how two key managerial tasks interact: that of growing the business through creating new investment opportunities and that of providing accurate information about these opportunities in the corporate budgeting process. We show how this interaction endogenously biases managers toward overinvesting in their own projects. This bias is exacerbated if managers compete for limited resources in an internal capital market, which provides us with a novel theory of the boundaries of the firm. Finally, managers of more risky and less profitable divisions should obtain steeper incentives to facilitate efficient investment decisions.