Internal Financing, Managerial Compensation and Multiple Tasks

Preliminary and incomplete We study the choice between internal and external financing with-out restricting the set of possible compensation schemes and capital allocation rules. We assume that managers can dedicate effort either to increase the short-term profitability of the firm, thus generating greater immediate cash-flow, or to improve the long-term perspectives. The firm has investment projects with decreasing returns to scale and unobservable quality. Managers have private information about project quality. In principle, under the optimal policy firms of higher quality devote more effort to improving profitability rather to generate cash. However, under incomplete information there is a bias toward cash production, since it is more observable and it does not generate information rents.