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Project Termination Decisions, Underinvestment and Overinvestment *
Author(s) -
TAN PATRICIA M. S.
Publication year - 2000
Publication title -
contemporary accounting research
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.769
H-Index - 99
eISSN - 1911-3846
pISSN - 0823-9150
DOI - 10.1111/j.1911-3846.2000.tb00914.x
Subject(s) - incentive , principal (computer security) , abandonment (legal) , private information retrieval , profit (economics) , work (physics) , sunk costs , economics , principal–agent problem , business , microeconomics , finance , computer science , engineering , political science , computer security , mechanical engineering , corporate governance , law
In this article, I use the principal‐agent framework to examine the incentives of risk‐and work‐averse agents to work on projects that are long‐term, multistage, and subject to abandonment. Periodic applications of effort by the agent are required. The agent also obtains private information as the project evolves, and he decides whether the project should be abandoned or continued. The principal not only seeks to provide incentives to induce the agent to take up such risky investments and work hard at them, but also seeks to provide incentives for the agent to abandon the project if the profit prospect is low. We show that the agent's decision to continue is not always aligned with the principal's desire. The result provides an economic rationale for the sunk cost phenomenon. There also exist conditions under which the agent chooses to prematurely abandon the project.