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Incentive Compatible Decision Making: Real Options with Adverse Incentives

Bissett School of Business, Mount Royal University and Canadian Institute for Innovation and Development, Calgary, AB T3E 6K6, Canada
Received: 9 January 2018 / Revised: 2 February 2018 / Accepted: 3 February 2018 / Published: 7 February 2018
(This article belongs to the Special Issue Multi-Criteria Decisions)
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Abstract

In this paper, we examine the real options approach to capital budgeting decision making in the presence of managerial adverse incentives. We show that real options have the potential to be value enhancing or value destroying depending on the managerial incentives that may result from having objectives different from firm value maximization. We further examine the possibility of using a generic residual income based rule of managerial compensation to induce the proper investment incentives and we seek to determine the cost-of-capital that must be employed in such a rule. Using numerical examples it is demonstrated that in general, a range of incentive compatible costs-of-capital exists across all managerial investment horizons but not across all managerial hurdle rates. View Full-Text
Keywords: corporate financial decisions; real options; adverse incentives; optimal boundary corporate financial decisions; real options; adverse incentives; optimal boundary
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This is an open access article distributed under the Creative Commons Attribution License which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited. (CC BY 4.0).
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Osakwe, C.-J.U. Incentive Compatible Decision Making: Real Options with Adverse Incentives. Axioms 2018, 7, 9.

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