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RFS Advance Access originally published online on April 2, 2004
Review of Financial Studies 2005 18(1):301-325; doi:10.1093/rfs/hhh005
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The Review of Financial Studies Vol. 18, No. 1 © 2005 The Society for Financial Studies; all rights reserved.

Decision Processes, Agency Problems, and Information: An Economic Analysis of Capital Budgeting Procedures

Anthony M. Marino and John G. Matsusaka
University of Southern California

Address correspondence to: John Matsusaka, Department of Finance and Business, Marshall School of Business, University of Southern California, Los Angeles, CA 90089-1427. E-mail: matsusak{at}rcf.usc.edu.

Corporations use a variety of processes to allocate capital. This article studies the benefits and costs of several common budget procedures from the perspective of a model with agency and information problems. Processes that delegate aspects of the decision to the agent result in too many projects being approved, while processes in which the principal retains the right to reject projects cause the agent to strategically distort his information about project quality. We show how the choice of a decision process depends on these two costs, and specifically on severity of the agency problem, quality of information, and project risk.


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