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RFS Advance Access published online on April 2, 2004
Review of Financial Studies, doi:10.1093/rfs/hhh005
Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved
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The Review of Financial Studies © The Society for Financial Studies 2004; all rights reserved.

Original Articles

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

Anthony M. Marino 1 and John G. Matsusaka 1*
1 Marshall School of Business, University of Southern California

* To whom correspondence should be addressed. E-mail: matsusak{at}marshall.usc.edu.


  Abstract

Corporations use a variety of processes to allocate capital. This paper 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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