DP12946 Managerial Spillovers in Project Selection

Author(s): Alejandro Francetich, Alfonso Gambardella
Publication Date: May 2018
Keyword(s): Corporate Strategy, decision-making, optimization, portfolios of real assets, uncertainty
JEL(s): C44, C61, L21, M21
Programme Areas: Industrial Organization
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12946

Selecting investment or research projects is a general managerial decision, which ranges from managing the portfolio of R&D or marketing campaigns within a company, to determining the very boundaries of the firm -- which units or divisions to encompass, what acquisitions or alliances to pursue. Projects are typically assessed individually. However, the different divisions of a firm share managerial resources, so managers can transfer successful practices from one unit to another unit within the firm, or to different firms within their portfolio. This introduces managerial spillovers, so the value of a portfolio is higher than the aggregate value of the isolated projects. In this paper, we analyze the problem of selecting projects in the presence of managerial spillovers, and provide a simple algorithm that implements its solution. We find that, while a project yielding negative marginal profit can be safely discarded, it may be profitable to pass on multiple projects at once even if some of them yield positive marginal profit. Thus, ignoring the spillovers across projects and focusing on marginal profit can lead to excessively diversified firms or economies, as opposed to firms or economies with fewer (albeit possibly larger-scale) projects.