Management Accounting Section Midyear Meeting

Optimal Design of Peer Monitoring Systems in Capital Budgeting

• In Event: Employee Selection and Competition

Abstract

This paper examines a two-agent capital budgeting setting where agents are privately informed regarding the profitability of their own project and have coarse information on the profitability of the other agent’s project. It is shown that at an arbitrarily low cost a principal can obtain agents’ information on the other agent’s project (peer monitoring). The model is extended to investigate optimal peer monitoring. Broad monitoring, which spreads monitoring resources equally across agents’ projects, is compared to focused monitoring which applies all monitoring resources to a single agent’s project. Three results emerge. First, if projects are sufficiently profitable, monitoring provides decreasing marginal benefits to the principal and hence broad monitoring is optimal. Second, there is an intermediate range of profitability where focused monitoring is optimal, below the intermediate range neither broad nor focused monitoring is useful. Third if projects have different levels of profitability and focused monitoring is optimal, the focus is on the more profitable project. The latter two results emerge because there is a threshold for monitoring to be useful.

Authors

• Anthony Meder, Binghamton University, SUNY

• Anthony Nikias, Farmingdale State College, SUNY

• Steven T. Schwartz, Binghamton University, SUNY

• Richard A. Young, The Ohio State University