Investor Protection and Capital Expenditures under Endogenous Time Inconsistency

The paper considers project implementation under a managerial system where the manager is monitored and can be replaced. It is shown that if it is more likely for the current manager to be in charge in the next period than a replacement, that the manager naturally possesses generalized hyperbolic discounting, and thus he faces a time inconsistency problem. Time inconsistent managers appear to lack incentive to undertake projects with immediate costs and long-lasting benefits especially when costs are large. Protection legislation can actually increase the time inconsistency, as managers may be less likely to take on projects that they are not likely to benefit them in the sense of diverting cash flows to pet projects rather than to productive long-term investment.