Managerial Reputation and Internal Reporting
[This paper demonstrates how a manager's concern for reputation can distort reports made to superiors about an investment project and hence, can affect a firm's capital budgeting decisions. In the first setting examined, a manager is assumed to know more than her superior about both her personal abilities and the prospects of a project under consideration. A manager's ability has two dimensions-ability to forecast a project's returns and productivity. A more talented manager has both better forecasting abilities and higher productivity than a less talented manager. It is shown that while a more talented manager always reports her assessment of a firm's project truthfully, a less talented manager's report depends on the magnitude of the difference in productivities between the more and less talented managers. When this productivity gap is large, the less talented manager conceals her lack of talent by claiming that the project's returns are low so as to discourage investment by the firm. Shifting blame to factors beyond her control protects the manager's reputation. Such managerial misreporting results in underinvestment by the firm. In contrast, where the productivity gap between a less talented manager and a more talented manager is small, a less talented manager guards her reputation by sometimes reporting favorable prospects and sometimes unfavorable prospects. This leads the firm either to over- or underinvest its resources, respectively. Thus, managerial misreporting occurs in equilibrium because a less talented manager tries to masquerade as a more talented manager, resulting in investment distortions. Whether a manager's concern for reputation exacerbates or mitigates the incentive problem depends on the manager's type. While the labor market forces align the incentives of a more talented manager with those of the firm, they also serve to misalign incentives for a less talented manager. In the second setting, this paper examines managerial investment distortion in the choice between short term and long term projects. Consider a scenario in which the outcome of a short term project is observed publicly earlier than that of a long term project. It is shown that managerial reputation incentives, coupled with superior two-dimensional private information, would cause a more talented manager to implement a short term or a long term project as dictated by the firm's interests, whereas a less talented manager with low productivity would choose a long term project. Through such choice, she is able to delay disseminating project outcome which is also informative about her type. A less talented manager who is relatively more productive would, however, implement a short term project sometimes and a long term project some other times. These investment distortions cannot be avoided either by restructuring the decision-making responsibilities or by the principal's committing to any implementation rules.]