Review of Accounting Studies

, Volume 12, Issue 1, pp 1–22 | Cite as

Performance measurement for investment decisions under capital constraints



An owner delegates investment decisions to a better informed manager whose time preferences are unknown to the owner. Due to exogenous capital constraints, not all profitable projects can be undertaken, and therefore the owner wants the manager to select the NPV-maximizing set of projects. We show that the relative benefit cost allocation scheme proposed by prior literature does not solve this problem. Adopting the same information structure as in Rogerson (J Polit Econ 105, 770–795, 1997) and Reichelstein (Rev Account Stud 2, 157–180, 1997), we demonstrate how to obtain robust goal congruence using residual income. The resulting revenue recognition and cost allocation rules lead to a performance measure reflecting the expected NPV-ranking of projects in each and every period.


Accrual accounting Capital budgeting EVA NPV maximization Performance measurement Revenue recognition Residual income 

JEL Classifications

M40 M41 G31 


  1. Antle, R., & Eppen, G. (1985). Capital rationing and organizational slack in capital budgeting. Management Science, 31, 163–174.CrossRefGoogle Scholar
  2. Antle, R., & Fellingham, J. (1990). Resource rationing and organizational slack in a two period model. Journal of Accounting Research, 28, 1–24.CrossRefGoogle Scholar
  3. Antle, R., & Demski, J.S. (1989). Revenue recognition. Contemporary Accounting Research, 6, 423–451.CrossRefGoogle Scholar
  4. Antle, R., Demski, J. S., & Ryan, S. G. (1994). Multiple sources of information, valuation, and accounting earnings. Journal of Accounting, Auditing & Finance, 9, 675–696.Google Scholar
  5. Baldenius, T., Dutta, S., & Reichelstein, S. (2006). Cost allocation for capital budgeting decisions. Working Paper. Stanford University.Google Scholar
  6. Baldenius, T., & Reichelstein, S. (2005). Incentives for efficient inventory management: The role of historical cost. Management Science, 51, 1032–1045.CrossRefGoogle Scholar
  7. Bareket, M. (2001). Investment decisions under capital constraints: The role of revenue recognition in performance measurement. Working paper. Columbia University.Google Scholar
  8. Brealey, R. A., & Myers, S. C. (1996). Principles of corporate finance (5th ed.). New York: McGraw-Hill.Google Scholar
  9. Dutta, S., & Zhang, X. (2002). Revenue recognition in a multiperiod agency setting. Journal of Accounting Research, 40, 67–83.CrossRefGoogle Scholar
  10. Dutta, S., & Reichelstein, S. (2002). Controlling investment decisions: Depreciation- and capital charges. Review of Accounting Studies, 7, 253–281.CrossRefGoogle Scholar
  11. Dutta, S., & Reichelstein, S. (2005). Accrual accounting for performance evaluation. Review of Accounting Studies, 10, 527–552.CrossRefGoogle Scholar
  12. Egginton, D. (1995). Divisional performance measurement: Residual income and the asset base. Management Accounting Research, 6, 201–222.CrossRefGoogle Scholar
  13. Ehrbar, A. (1998). EVA the real key to creating wealth. New York: Wiley.Google Scholar
  14. Feltham, G., & Ohlson, J. (1995). Valuation and clean surplus accounting for operating and financial decision. Contemporary Accounting Research, 11, 689–731.Google Scholar
  15. Financial Accounting Standards Board (FASB) (1984). Statement of financial accounting standards no. 5. Recognition and measurement in financial statements of business enterprises. Norwalk, CT: FASB.Google Scholar
  16. Hingorani, V. L., & Mukherjee, T. K. (1999). Capital rationing decisions of Fortune 500 firms: A survey. Financial Practice and Education, 1, 7–15.Google Scholar
  17. Liang, P. J. (2000). Accounting recognition, moral hazard, and communication. Contemporary Accounting Research, 17, 457–490.CrossRefGoogle Scholar
  18. Mishra, B., & Vaysman, I. (2004). Delegating investment decision. Working Paper. University of Texas, Austin.Google Scholar
  19. Mohnen, A. (2002). Performancemessung und die Steuerung von Investitionsentscheidungen. Beiträge zur betriebswirtschaftlichen Forschung, Wiesbaden: Gabler Verlag und Deutscher Universitätsverlag.Google Scholar
  20. Mohnen, A. (2005). Good News für die Steuerung von Investitionsentscheidungen—Eine Verallgemeinerung des relativen Beitragsverfahrens. Zeitschrift für Betriebswirtschaft, 75(3), 277–297.Google Scholar
  21. Ohlson, J., & Zhang, X. (1998). Accrual accounting and equity valuation. Journal of Accounting Research, 36, 85–112.CrossRefGoogle Scholar
  22. Ohlson, J. (1995). Earnings, book value and dividends in security valuation. Contemporary Accounting Research, 11, 661–687.CrossRefGoogle Scholar
  23. Preinreich, G. (1937). Valuation and amortization. The Accounting Review, 12, 209–226.Google Scholar
  24. Ramakrishnan, R. (1988). Accrual accounting and incentives: Depreciation methods for investment centers. Working paper. Columbia University.Google Scholar
  25. Reichelstein, S. (1997). Investment decisions and managerial performance evaluation. Review of Accounting Studies, 2, 157–180.CrossRefGoogle Scholar
  26. Rogerson, W. (1997). Inter-temporal cost allocation and managerial investment incentives. Journal of Political Economy, 105, 770–795.CrossRefGoogle Scholar
  27. Ryan, S. (1988). Structural models of the accounting process and earnings. Ph.D. Dissertation. Stanford University.Google Scholar
  28. Stewart, B. (1991). The quest for value. New York: Harper Collins Publishers.Google Scholar
  29. Wagenhofer, A. (2003). Accrual-based compensation, depreciation and investment decisions. European Accounting Review, 12, 287–309.CrossRefGoogle Scholar
  30. Wei, D. (2004). Inter-departmental cost allocation and investment incentives. Review of Accounting Studies, 9, 97–116.CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media, LLC 2007

Authors and Affiliations

  1. 1.Department of Business Administration and Personnel EconomicsUniversity of CologneCologneGermany
  2. 2.Fuqua School of BusinessDuke UniversityDurhamUSA

Personalised recommendations