Controlling Investment Decisions: Hurdle Rates and Intertemporal Cost Allocation

39 Pages Posted: 6 Jan 2000

See all articles by Sunil Dutta

Sunil Dutta

University of California, Berkeley - Haas School of Business

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business; CESifo (Center for Economic Studies and Ifo Institute)

Date Written: November 2000

Abstract

We examine alternative performance measures for a manager who has superior information about the profitability of an investment project and contributes to periodic operating cash flows through his efforts. We find that residual income based on a suitably chosen depreciation schedule is an optimal performance measure. To address the underlying agency problem, the charge for capital in the calculation of residual income must be based on a hurdle rate that exceeds the principal's cost of capital. We also establish that proper matching of periodic operating cash flows with a share of the initial investment cost (via depreciation charges) is essential if the performance measure is to support optimal incentive provisions for a sufficiently wide class of agency problems.

JEL Classification: D82, D92, M41

Suggested Citation

Dutta, Sunil and Reichelstein, Stefan J., Controlling Investment Decisions: Hurdle Rates and Intertemporal Cost Allocation (November 2000). CESifo Working Paper Series No. 354. Available at SSRN: https://ssrn.com/abstract=200848

Sunil Dutta (Contact Author)

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States
510-643-1229 (Phone)
510-643-1412 (Fax)

Stefan J. Reichelstein

Stanford University - Stanford Graduate School of Business ( email )

655 Knight Way
Stanford, CA 94305-5015
United States
650-736-1129 (Phone)
650-725-7979 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

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