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Why do Hurdle Rates Differ from the Cost of Capital?

Driver, Ciaran and Temple, Paul (2010) 'Why do Hurdle Rates Differ from the Cost of Capital?' Cambridge Journal of Economics, 34 (3). pp. 501-523.

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Abstract

This article considers the role of hurdle rates in the analysis of investment decisions, analysing a sample of business units from the PIMS (Profit Impact of Marketing Strategy) databank of North American companies, which provides rarely observed data on hurdle rates. Although the standard literature suggests that firms should only invest if the return exceeds the cost of capital, there are several theories that explain the use of investment hurdle rates that differ from discount rates. In fact, our data show that instances where hurdle rates are either above or below the discount rate are common. In a statistical analysis, we find that this behaviour can be explained by a combination of agency theory and real options theory. We take this as important evidence that a full explanation of capital investment cannot be accomplished without a consideration of behavioural and strategic influences on the investment decision

Item Type: Articles
SOAS Departments & Centres: Faculty of Law and Social Sciences > Department of Financial and Management Studies
ISSN: 14643545
DOI (Digital Object Identifier): 10.1093/cje/bep013
Depositing User: Mutsa Marau
Date Deposited: 22 Oct 2010 10:28
URI: http://eprints.soas.ac.uk/id/eprint/10508

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