We analyze how the costs of smoothly adjusting capital, such as incentive costs, affect investment timing. In our model, the owner of a firm holds a real option to increase a lumpy form of capital and can also smoothly adjust an incremental form of capital. Increasing the cost of incremental capital can delay or accelerate investment in lumpy capital. Incentive costs due to moral hazard are a natural source of costs for the accumulation of incremental capital. When moral hazard is severe, delaying investment in lumpy capital is costly, and it is optimal to overinvest relative to the first-best case.

Additional Metadata
Keywords Moral Hazard, Dynamic Contracting, Real Options.
JEL Capital Budgeting; Investment Policy (jel G31), Intertemporal Firm Choice and Growth, Investment, or Financing (jel D92), Economics of Contract Law (jel D86)
Persistent URL hdl.handle.net/1765/116406
Journal The Review of Financial Studies
Gryglewicz, S, & Hartman-Glaser, B. (2019). Investment Timing and Incentive Costs. The Review of Financial Studies, Accepted. Retrieved from http://hdl.handle.net/1765/116406