Valuation of irreversible investments : private information about the investment cost

Abstract

This article examines dynamic investment decisions when there is an agency problem. A principal delegates the decision of an investment strategy of a project to an agent. The agent has private information about the investment cost, whereas the principal only knows the probability distribution of the cost. The principal's problem is how to compensate the agent in order to optimize the value of the principal's investment opportunity. Owing to the asymmetric information, it may be optimal for the principal to leave the agent some "information rent". An optimal compensation function dependent on the observable output from the investment is found.