Contracting on real option payoffs

We consider the design of contracts that pay managers on the basis of a project's payoff. We show that a contract that induces appropriate timing of project investment by a privately informed risk neutral manager will not offer proper incentives to forgo perk consumption at the time of investment. Under the firm's optimal contract within the class of payments that do not depend on time of investment, the manager waits too long to invest. The optimal contract can be implemented with a call option on the project payoff.