Optimal Capital Allocation Using Raroc and Eva

37 Pages Posted: 19 Jan 2004

See all articles by Neal Stoughton

Neal Stoughton

Vienna University of Economics and Business; Vienna Graduate School of Finance (VGSF)

Josef Zechner

Vienna University of Economics and Business

Multiple version iconThere are 2 versions of this paper

Date Written: January 2004

Abstract

This Paper analyses firms' capital allocation decisions when optimal capital structure is linked to the risk of underlying assets and when equity capital is costly and cannot be raised instantaneously. In the model, division managers receive private information and authority is delegated to them over risky project choices. The optimal mechanisms are related to EVA compensation and RAROC performance measurement systems. In the optimal mechanism, position limits will be employed but are not always completely utilized. Hurdle rates reflect capital allocation through a division-specific capital structure. In the multidivisional context the optimal capital allocation mechanism incorporates valuable externalities leading to overall firm EVA maximization.

JEL Classification: G20, G21, G30, G31

Suggested Citation

Stoughton, Neal M. and Zechner, Josef, Optimal Capital Allocation Using Raroc and Eva (January 2004). CEPR Discussion Paper No. 4169. Available at SSRN: https://ssrn.com/abstract=490341

Neal M. Stoughton (Contact Author)

Vienna University of Economics and Business ( email )

Austria

Vienna Graduate School of Finance (VGSF) ( email )

Austria

Josef Zechner

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien A-1019
Austria

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