Incentivizing Irreversible Investment

41 Pages Posted: 19 Oct 2017 Last revised: 30 Dec 2020

See all articles by Dmitry Livdan

Dmitry Livdan

University of California, Berkeley

Alexander Nezlobin

London School of Economics & Political Science (LSE) - London School of Economics

Date Written: September 7, 2020

Abstract

Existing dynamic investment models that show that a manager can be incentivized to implement the optimal investment policy rely on the assumption that the firm is operating in an ever-expanding product market. This paper presents an analytically tractable, discrete-time, neoclassical model with irreversible investment and the possibility of unfavorable demand events. We show that even when the principal is uninformed about changes in demand for the firm's output, there exists a performance measurement system that leads to goal congruent investment incentives for the manager. If the principal can observe the unfavorable demand events, then goal congruence can be achieved using very simple accrual accounting rules, such as straight-line depreciation.

Suggested Citation

Livdan, Dmitry and Nezlobin, Alexander, Incentivizing Irreversible Investment (September 7, 2020). Available at SSRN: https://ssrn.com/abstract=3055506 or http://dx.doi.org/10.2139/ssrn.3055506

Dmitry Livdan (Contact Author)

University of California, Berkeley ( email )

545 Student Services Building, #1900
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Berkeley, CA 94720
United States
(510) 642-4733 (Phone)

Alexander Nezlobin

London School of Economics & Political Science (LSE) - London School of Economics ( email )

United Kingdom

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