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Why do hurdle rates differ from the cost of capital?

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  • Ciaran Driver
  • Paul Temple

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. Copyright The Author 2009. Published by Oxford University Press on behalf of the Cambridge Political Economy Society. All rights reserved., Oxford University Press.

Suggested Citation

  • Ciaran Driver & Paul Temple, 2010. "Why do hurdle rates differ from the cost of capital?," Cambridge Journal of Economics, Cambridge Political Economy Society, vol. 34(3), pages 501-523.
    • Handle: RePEc:oup:cambje:v:34:y:2010:i:3:p:501-523
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    File URL: http://hdl.handle.net/10.1093/cje/bep013
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    Cited by:

    1. Driver, Ciaran & Guedes, Maria João Coelho, 2012. "Research and development, cash flow, agency and governance: UK large companies," Research Policy, Elsevier, vol. 41(9), pages 1565-1577.
    2. Hong Bo & Ciaran Driver, 2012. "Agency Theory, Corporate Governance and Finance," Chapters, in: Michael Dietrich & Jackie Krafft (ed.), Handbook on the Economics and Theory of the Firm, chapter 11, Edward Elgar Publishing.

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