Corporate Investment Decision Practices and the Hurdle Rate Premium Puzzle

60 Pages Posted: 31 Jan 2007

See all articles by Iwan Meier

Iwan Meier

HEC Montreal - Department of Finance

Vefa Tarhan

Loyola University of Chicago - School of Business Administration; Northwestern University - Kellogg Graduate School of Management

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

Meier, Iwan and Tarhan, Vefa, Corporate Investment Decision Practices and the Hurdle Rate Premium Puzzle (January 28, 2007). Available at SSRN: https://ssrn.com/abstract=960161 or http://dx.doi.org/10.2139/ssrn.960161

Iwan Meier (Contact Author)

HEC Montreal - Department of Finance ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7 H2J 2K9
Canada
(514) 340-3198 (Phone)

Vefa Tarhan

Loyola University of Chicago - School of Business Administration ( email )

820 North Michigan Avenue
Chicago, IL 60611
United States

Northwestern University - Kellogg Graduate School of Management ( email )

2001 Sheridan Road
Evanston, IL 60208
United States

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