Reputation, Information and Project Termination in Capital Budgeting

The Net Present Value (NPV) rule of financial theory gives management a decisive criterion for choosing between abandonment versus continuation of capital projects. There is extensive evidence, however, that management chooses to delay the abandonment of unprofitable projects. This paper attempts to explain management's reluctance to abide by the NPV criterion. The concept of a Reputation Adjusted Net Present Value is introduced in an environment where management knows more about the true value of a project than do stakeholders. The model indicates that, in such an environment, the continuation of a negative NPV project may maximize firm value.