Capital (Mis)allocation and Incentive Misalignment

We study how managerial incentives affect the allocation of capital inside firms. To identify the effect of incentives on investment decisions we use a within-firm estimator that exploits variation across capital goods and a US accounting reform as an exogenous shock to managers' short-termist incentives. Our evidence shows that capital (mis)allocation within firms can be amplified by short-termist incentives. More short-term incentives cause a shift in investment expenditures away from durables towards more short-lived capital goods, effectively shortening the durability of firms' capital stocks. To study the economic implications of this within-firm misallocation channel, we then build a model of firm investments with incentive frictions that we calibrate to the US economy. We show that even moderate increases in short-termist incentives, such as those around the accounting reform, may cause substantial inefficiencies. These inefficiencies lead to large within-firm spreads in the marginal products of capital goods, causing long-run declines in output and real wages.