Corporate Investment Decision Practices and the Hurdle Rate Premium Puzzle
60 Pages Posted: 31 Jan 2007
Date Written: January 28, 2007
Abstract
We survey a cross-section of 127 companies to gain insight on various dimensions of firms' investment decisions. The questions posed by our survey address the hurdle rates firms use, calculations of project-related cashflows, and the interaction of cashflows and hurdle rates. Unlike previous studies which examine investment decisions by either using survey data or data obtained from financial tapes, we use both sets of data. This approach produced one of our primary findings that there is a hurdle rate premium puzzle, in that hurdle rates used by our sample of firms exceed their cost of capital, that we calculate using Compustat data, by a substantial magnitude. We investigate the determinants of this puzzle and find that it is related to factors that reflect financial flexibility considerations, managers' confidence in the estimates of beta, financial health of firms, and the past performance of the industry they are in. Finally, our findings show that survey firms do not always appear to handle the cashflow dimension of their investment decisions in a consistent manner.
Keywords: Discount rate, Cost of capital, Hurdle rate premium, Cash flow calculation, Project valuation, Survey
JEL Classification: G31
Suggested Citation: Suggested Citation
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