The dynamics of project standards

Abstract

We study how a principal decides the duration of a project based on an agent's report about the growth rate of the project's profitability. The principal optimally commits to a project standard, shutting down whenever the project's profitability falls below the standard. Low-growth projects receive stationary standards, whereas high-growth projects receive standards that either increase unboundedly over time (with growing inefficiencies upon shut down), decrease towards the principal's first-best standard (with vanishing inefficiencies upon shut down) or use the same standard as the low-growth project. We explore what type of information is optimally elicited using dynamic standards and show that our results are robust to allowing for transfers and costly information acquistion by the principal.