RFS Advance Access originally published online on October 2, 2008
Review of Financial Studies 2009 22(1):219-255; doi:10.1093/rfs/hhn085
| ||||||||||||||||||||||||||||||||||||||||||||||||||||
Promotion Tournaments and Capital Rationing
McCombs School of Business, University of Texas at Austin
Merage School of Business, University of California, Irvine
Fisher College of Business, Ohio State University
Send correspondence to John Persons, Ohio State University, 2100 Neil Avenue, Columbus, OH 43210; telephone: (614) 292-4318; E-mail: jp{at}cob.osu.edu.
JEL Classification: G30, G31, G39
 |
Abstract |
|---|
We analyze capital allocation in a conglomerate where divisional managers with uncertain abilities compete for promotion to CEO. A manager can sometimes gain by unobservably adding variance to divisional performance. Capital rationing can limit this distortion, increase productive efficiency, and allow the owner to make more accurate promotion decisions. Firms for which CEO talent is more important for firm performance are more likely to ration capital. A rationed manager is more likely to be promoted even though all managers are identical ex ante. When the tournament payoff is relatively small, offering an incentive wage can be more efficient than rationing capital; however, when tournament incentives are paramount, rationing is more efficient.
We are grateful for helpful comments and suggestions from an anonymous referee, Major Coleman, Adolfo de Motta (WFA discussant), Denis Gromb, Rose Liao, Sonya Seongyeon Lim, Terrance Odean (the Editor), Christof Stahel, Karen Wruck, and seminar participants at Ohio State University and Hope College, and at the 2006 Western Finance Association meetings.