Managerial Performance Evaluation

In a dynamic setting with demand following a random process, we ask how investment and operating decisions can be delegated to a manager with unknown time preferences. Only the manager observes the demand realization in each period and, therefore, has private information when choosing whether to acquire the productive asset and, subsequently, how to utilize it. We derive accrual accounting-based performance measures under which the manager will make the efficient decisions provided the investment date is exogenously given. Unless the market is expected to contract over time, the corresponding accounting rules are more decelerated than with deterministic demand, because of the option to idle capacity in case of negative demand shocks. We then extend our results to a scenario in which the investment date is endogenously determined, i.e., the firm has an option to postpone its investment.