Irreversible Investment, Capital Costs and Productivity Growth: Implications for Telecommunications

Abstract

This paper develops a model incorporating costly disinvestment and estimates the associated commitment premium required to invest in telecommunications. Results indicate that the irreversibility premium raises the opportunity cost of capital by 70 percent. This implies an average annual hurdle rate of return of 14 percent over the period 1986-2002. Irreversibility creates a distinction between observed and adjusted TFP growth. Observed growth, which omits the premium, annually averaged 2.8 percent from 1986 to 2002. This rate exceeded the (premium) adjusted TFP growth by 0.7 percentage points, and therefore average annual observed productivity growth overestimated the corrected rate by 33 percent.