This paper considers the profit‐maximization problem of a firm that must make sunk investments in long‐lived assets to produce output. It is shown that if per‐period accounting income is calculated using a simple and natural allocation rule for investment, called the relative replacement cost (RRC) rule, under a broad range of plausible circumstances, the firm can choose the fully optimal sequence of investments over time simply by choosing a level of investment each period in order to maximize the next period’s accounting income. Furthermore, in a model in which shareholders delegate the investment decision to a better‐informed manager, it is shown that if accounting income based on the RRC allocation rule is used as a performance measure for the manager, robust incentives are created for the manager to choose the profit‐maximizing sequence of investments, regardless of the manager’s own personal discount rate or other aspects of the manager’s personal preferences.

We provide evidence of advantageous selection in the Medigap insurance market and analyze its sources. Conditional on controls for Medigap prices, those with Medigap spend, on average, $4,000 less on medical care than those without. But if we condition on health, those with Medigap spend $2,000 more. The sources of this advantageous selection include income, education, longevity expectations, and financial planning horizons, as well as cognitive ability. Conditional on all these factors, those with higher expected medical expenditures are more likely to purchase Medigap. Risk preferences do not appear as a source of advantageous selection; cognitive ability is particularly important.