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.