Managerial compensation, investment decisions, and truthfully reporting

Abstract

This paper provides a formal analysis of investment decisions with special emphasis to mechanisms which induce managers to reveal their knowledge truthfully. In a one-period context ‘knowledge’ usually means the profit ratio. In a multi-period setting ‘knowledge’ is referred to the (multivariate) cash flow stream or the (univariate) net present value. Both situations are analysed in the paper. We start with the basic case ‘one firm, one manager’ and continue with the case ‘divisional firm, division managers’. With respect to the first case, we criticise two approaches (Rogerson, JPolE 105(4):770–795, 1997; Reichelstein, RAS 2(2):157–180, 1997) and develop a solution based on extended incentive contracts. To tackle the second case, we analyse pros and cons of Groves schemes.