Accounting Papers

Document Type

Working Paper

Date of this Version

4-2013

Publication Source

Management Science

Volume

59

Issue

4

Start Page

869

Last Page

881

DOI

10.1287/mnsc.1120.1621

Abstract

Capital budgeting frequently involves multiple stages at which firms can continue or abandon ongoing projects. In this paper, we study a project requiring two stages of investment. Failure to fund Stage 1 of the investment precludes investment in Stage 2, whereas failure to fund Stage 2 results in early termination. In contrast to the existing literature, we assume that the firm can limit the manager's informational rents with the early termination of the project. In this setting, we find that the firm optimally commits to a capital allocation scheme whereby it forgoes positive net present value (NPV) projects at Stage 1 (capital rationing), whereas at Stage 2, depending on the manager's previous report, it sometimes implements projects with a negative continuation NPV but in other situations forgoes implementing projects with positive continuation NPVs.

Keywords

accounting, capital budgeting, resource allocation, multistaged financing, abandonment options, milestone-contingent investments

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Date Posted: 27 November 2017

This document has been peer reviewed.