AGENCY PROBLEMS ASSOCIATED WITH MANAGERS HAVING DISINCENTIVES TO ABANDON INVESTMENTS

Non-optimal abandonment policy can arise from managers having disincentives to terminate projects. Statman and Caldwell demonstrate that psychological and pecuniary disincentives cause agency costs that are borne by shareholders; they argue that market forces and financial managers are capable of eliminating or greatly reducing the agency costs. This paper takes the pessimistic view that, because of the phenomenon of selective filtering of information, the agency costs are not easily averted. The agency costs are manifest by (1) overinvestment at the time of project initiation, (2) practices that increase the value of risky debt, (3) poor investment policy when capital rationing exists, and (4) non-optimal working capital management decisions. Filtering of information is exacerbated by management information systems that are inadequate to provide the quality of data needed for capital budgeting decisions.