[Firms' investment practices often seem to be suboptimal; for example, they may ration capital or underinvest in risky projects. Recent research (e.g., Antle and Eppen 1985, Antle and Fellingham 1990, Harris et al. 1982) argues that these practices might be optimal responses to contracting frictions that arise from information asymmetry among the members of the firm. Analyzing a two-person firm, these studies endow the manager with pre-decision information about the returns from a given project and examine the owner's optimal response to the information asymmetry. This article expands the problem in two ways. First, it considers the choice between two competing projects. Second, it explicates the source of the manager's information superiority: proximity to the firm's operations advantage the manager in both acquiring and knowing the cost-benefit of additional information pertinent to project choice. Because of the manager's advantage, the owner cannot infer why the project was selected. The owner's response to the information asymmetry must optimize over both the information-acquisition and resource-allocation decisions. This article considers a model in which the manager must choose between a risk-free and a risky project. The owner delegates project selection because of the manager's pre-contract information superiority and because only the manager can obtain post-contract additional, costly information. Delegating project choice, however, creates a coordination problem because of the owner's inability to observe whether the manager expended effort on information search and because the value of additional information depends on the manager's pre-contract information (i.e., on the manager's type). Using the observed variables (project choice and realized profit), the optimal contract must (1) motivate a subset of manager types to select the project after expending effort on information search, and (2) motivate the complementary set to condition project selection on their pre-contract information alone. The model considered here is related to that of Demski and Sappington (1987) which considers issues involved in contracting with an "expert" who is uniquely qualified to acquire pertinent information, and Lambert (1986) applying this concept to a project-selection setting. Pre-contract asymmetry about the value of search is the crucial difference between previous research and this study. Absent information asymmetry (in the first-best solution), the information-acquisition problem is separable from the resource-allocation problem. The owner asks for search only from those manager types for whom the value to search exceeds cost. (The set of such manager types is convex because the value to search is concave in manager type.) Also, the manager uses all available information to choose the more profitable project. However, the owner cannot attain this first-best solution without information about manager type and information search. The two problems cannot be decomposed. As a result, the optimal (second-best) contract always induces distortions in information acquisition and, for the case of the risk-averse manager, induces overinvestment in the risky project. Furthermore, communication of the search result is strictly valuable. The results suggest that optimal responses to information asymmetry among the members of the firm could result in practices that seem to disregard the value of information search and to use acquired information sub-optimally. The results also lend support to the use of accounting reports, such as budgets, in managerial performance evaluation.]

This article examines the value of communication in a setting in which the owner and the manager of a firm differentially share the costs and benefits of information acquisition. Absent communication, the optimal contract induces allocative distortions to enhance the information content (about whether the manager expended effort in searching for additional information pertinent to the allocation decision) of the observed output. Communication has value because it reduces the value of the information externality in the observed output and, thus, reduces allocative distortions. Hence, the results lend support to the use of accounting reports (e.g., budgets) and ex post monitoring of decisions (e.g., an internal audit) in managerial performance evaluation. However, unless the manager's search is observable, it is optimal to use the information in the observed outcomes in compensating the manager. This finding highlights that the optimality of observed resource allocation practices cannot be evaluated independently of the larger problem of motivating the manager to acquire pertinent information because the information acquisition and resource allocation problems cannot be decomposed. Résumé. L'auteur examine la valeur de la communication dans un environnement dans lequel le propriétaire et le gestionnaire d'une entreprise partagent de façon différente les coûts et les avantages de l'acquisition d'information. Si la communication est inexistante, le contrat optimal induira des distorsions dans l'affectation des ressources visant à augmenter le contenu en information (relativement à l'ampleur des efforts déployés par le gestionnaire pour obtenir de l'information supplémentaire pertinente à la décision d'affectation) des résultats observés. La valeur de la communication réside dans le fait qu'elle réduit celle de l'extériorité de l'information dans les résultats observés et, par conséquent, diminue les distorsions dans l'affectation des ressources. Les résultats viennent donc appuyer l'utilisation des rapports comptables (les budgets, par exemple) et du contrôle a posteriori des décisions (la vérification interne, par exemple) dans l'evaluation du rendement du gestionnaire. Toutefois, à moins que la recherche d'information par le gestionnaire ne soil observable, il est optimal d'utiliser l'information contenue dans les résultats observés pour décider de la rémunération du gestionnaire. Cette conclusion met en relief le fait que le caractère optimal des méthodes observées d'affectation des ressources ne peut être évalué isolément du problème plus large de la motivation du gestionnaire à faire l'acquisition de l'information pertinente, les problèmes d'acquisition d'information et d'affectation des ressources étant indissociables.

This paper considers investment in a two‐period principal‐agent model. In each period the agent has pertinent pre‐ and postdecision information about the returns from the project. Messages from the agent are interpreted as a budget and a self‐reported variance. The paper examines when the sequential resolution of the uncertainty in profits would, by itself, result in a long‐term contract. This focus is maintained by eliminating any role for learning or consumption smoothing in the contracting arrangement. Because they allow for commitment to future investment strategies contingent on current‐period reports, relative to short‐term contracts, long‐term contracts exhibit efficiency gains. There is an endogenous demand for both budget and variance reports. By considering an N ‐period model, gains from long‐term contracting are shown to be positively related to the principal's flexibility in committing to future investment strategies that are contingent on the agent's prior period report(s). Sequential resolution of the agent's uncertainty, either within or across periods, strictly enhances the demand for long‐term contracting. The results suggest that expenditures involved in obtaining periodic budget and variance reports from the manager and in keeping a history of the communications may be cost justified by ex ante expected gains in efficiency. Résumé. L'auteur envisage l'investissement dans l'optique d'un modèle mandant‐mandataire comportant deux périodes. Avant et au terme de chaque période, le mandataire dispose d'informations pertinentes relatives au rendement du projet. Les messages du mandataire sont interprétés comme étant un budget et un relevé des écarts. L'auteur examine à quel moment la transformation séquentielle de l'incertitude en gains donnerait lieu, en soi, à un contrat à long terme. Cet axe de recherche est maintenu grâce à l'élimination de tout effet d'apprentissage ou de nivellement de la consommation dans les dispositions contractuelles. Étant donné que les contrats à long terme permettent de s'engager dans des stratégies éventuelles d'investissement en fonction des résultats de la période en cours, ils offrent des gains sur le plan de l'efficience. Il existe une demande endogène de rapports budgétaires aussi bien que de relevés des écarts. Lorsqu'on utilise un modèle de N périodes, les gains qu'offrent les contrats à long terme affichent une relation positive avec la souplesse du mandant dans son engagement à l'égard de stratégies éventuelles d'investissement en fonction des rapports produits par le mandataire pour la ou les périodes précédentes. La transformation séquentielle de l'incertitude du mandataire, que ce soit à l'intérieur d'une même période ou au cours d'une période subséquente, favorise au sens strict la demande de contrats à long terme. Selon les résultats de l'étude, les dépenses que supposent l'obtention périodique de budget et de relevés des écarts par le gestionnaire et le maintien d'un dossier des communications seraient justifées par les perspectives ex ante de gains au chapitre de l'efficience.

Reviews the book "Business Behavior and Information," edited by Yuji Ijiri and Isao Nakano.

Ideally, firms should jointly solve capacity-planning and product-pricing problems. In practice, informational limitations and cognitive bounds may force firms to sequentially solve the two problems. For example, a firm may plan capacity using limited demand information, and update prices subsequently once additional demand information becomes available. In a simple setting, we characterize the economic loss due to such sequential planning. We use simulation experiments to assess the extent of this loss in more complex settings. We find a relatively low loss if the firm plans for capacity using limited demand information and subsequently adjusts product prices to reflect realized market conditions. However, even “reasonable” restrictions on the subsequent price adjustment (e.g., constraining adjusted prices to always exceed full cost) lead to significant economic loss.

[The quality of capacity planning significantly affects firm profitability, particularly for firms in service industries. In practice, firms use product cost data to infer the expected cost of under- and over-stocking capacity and to determine installed capacity. Theory shows that this is not optimal practice. In light of the informational and computational complexities associated with the optimal theoretical formulation, the use of product cost may be justified as a heuristic. For a multi-product, multi-resource firm, we use simulations to investigate the efficiency of four cost-based decision rules in determining the expected cost of under- and over-stocking capacity. Results indicate surprisingly high performance levels, relative to a benchmark solution. The performance of the product-based planning rule deteriorates as products increasingly share capacity resources. The opposite is true for resource-focused rules. There appears to be significant value from identifying mechanisms to balance installed capacity across resources.]

[This paper examines whether firms exhibiting improved inventory utilization subsequent to JIT adoption achieve a corresponding increase in their Return on Assets (ROA) and whether firm-specific characteristics affect such ROA responses. On average, we do not find a significant ROA response to JIT adoption. Cross-sectionally, JIT adopting firms with a diffuse customer base have a superior ROA response relative to both adopting firms with a high degree of customer concentration and their matched control firms. Evidence is consistent with a superior ROA response for firms with lower inventory turns in the adoption year, particularly for work-in-process inventory. Data do not support the prediction that firms with lower committed costs will report a greater ROA response than firms with a higher proportion of committed costs.]

For a common resource, we suggest that the benefits of fixed cost allocations lie not in inducing optimal utilization of available capacity but in deciding how much capacity to acquire. In the presence of sequential information asymmetry between the owner and two symmetric users of the resource, we show that cost allocations form a part of the optimal incentive contract. We derive an optimal cost allocation scheme and provide an explicit link between the allocated costs under this scheme and the fixed costs of the resource. Résumé. Selon les auteurs, pour une ressource commune, les avantages de la répartition des coûts fixes résident non pas dans l'induction d'une utilisation optimale de la capacité disponible, mais dans la décision relative à la capacité devant être acquise. En présence d'asymétrie de l'information séquentielle entre le propriétaire et deux utilisateurs symétriques de la ressource, les auteurs démontrent que la répartition des coûts est un élément qui entre dans le contrat d'intéressement optimal. Ils dérivent un plan optimal de répartition des coûts et établissent un lien explicite entre les coûts répartis au moyen de ce plan et les coûts fixes de la ressource.

Ideally, firms should jointly solve capacity‐planning and product‐pricing problems. In practice, informational limitations and cognitive bounds may force firms to sequentially solve the two problems. For example, a firm may plan capacity using limited demand information, and update prices subsequently once additional demand information becomes available. In a simple setting, we characterize the economic loss due to such sequential planning. We use simulation experiments to assess the extent of this loss in more complex settings. We find a relatively low loss if the firm plans for capacity using limited demand information and subsequently adjusts product prices to reflect realized market conditions. However, even “reasonable” restrictions on the subsequent price adjustment (e.g., constraining adjusted prices to always exceed full cost) lead to significant economic loss.