Incentives, Project Choice and Dynamic Multitasking* (Job Market Paper)

I study the optimal choice of investment projects in a continuous-time moral hazard model with multitasking. While in the first best, projects are invariably chosen by the net present value (NPV) criterion, moral hazard introduces a cutoff for project selection which depends on both a project’s NPV as well as its risk-return ratio. The cutoff shifts dynamically depending on the past history of shocks, the current firm size, and the agent’s continuation value. When the ratio of continuation value to firm size is large, investment projects are chosen more efficiently, and project choice depends more on the NPV and less on the risk-return ratio. The optimal contract can be implemented with an equity stake, bonus payments, as well as a personal account. Interestingly, when the contract features equity only, the project selection criterion resembles a hurdle rate.