Project Selection, Income Smoothing and Bayesian Learning

University of Frankfurt Working Paper

36 Pages Posted: 19 Sep 2003

See all articles by Christian Gaber

Christian Gaber

Goethe University Frankfurt - Department of Accounting and Auditing

Date Written: June 2003

Abstract

The use of fixed capital budgets is an empirically well-documented phenomenon in business practice. Whensoever some profitable investment opportunities cannot be realized, managers have to make investment decisions between mutually exclusive investment opportunities. In a multiperiod agency setting this paper analyses accounting rules that provide managerial incentives for efficient project selection when a short-sighted manager is rewarded based on residual income. Before having access to profitable investment opportunities the agent has to expend unobservable effort. At each date the less informed principal observes a noisy cash flow signal which is informative about the agent's investment decision. By updating prior beliefs the principal faces a trade-off between agency costs resulting from differences in discount rates and the benefits resulting from the information content of the noisy cash flow signals.

Keywords: performance measurement, investment incentives, residual income

JEL Classification: M40, M41, M46, G31, D82

Suggested Citation

Gaber, Christian, Project Selection, Income Smoothing and Bayesian Learning (June 2003). University of Frankfurt Working Paper, Available at SSRN: https://ssrn.com/abstract=431500 or http://dx.doi.org/10.2139/ssrn.431500

Christian Gaber (Contact Author)

Goethe University Frankfurt - Department of Accounting and Auditing ( email )

Mertonstr. 17-25
60325 Frankfurt
Germany

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