Performance-based bonuses for investment and abandonment decisions

- We derive optimal performance-based bonuses for investment and abandonment decisions.
- Compensation that is optimal for investment generates agency conflicts in abandonment decisions.
- Shareholders should adjust the bonus contract for investment to mitigate any agency problems in the abandonment decision.
- Managers are concerned only with their effort costs if they receive the optimal bonus for abandonment decisions.

This paper examines whether a performance-based bonus for a manager's investment influences her abandonment decision. First, we derive optimal performance-based bonuses for investment and abandonment decisions. Second, we show that there could be a discrepancy between the managers abandonment timing and that of the shareholders, even though an appropriate performance-based bonus was compensated to mitigate agency conflicts in the investment decision. Third, we also show that as long as the manager is contracted to receive the optimal performance-based bonus for the abandonment decision, only the effort costs that she incurs affect the abandonment timing.