Rational Capital Budgeting in an Irrational World

J. OF BUSINESS, Vol. 69 No. 4, October 1996

Posted: 15 Jan 1997

See all articles by Jeremy C. Stein

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Abstract

This article addresses the following basic capital budgeting question: Suppose that cross-sectional differences in stock returns can be predicted based on variables other than beta (e.g., book-to-market), and that this predictability reflects market irrationality rather than compensation for fundamental risk. In this setting, how should companies determine hurdle rates? I show how factors such as managerial time horizons and financial constraints affect the optimal hurdle rate. Under some circumstances, beta can be useful as a capital budgeting tool, even if it is of no use in predicting stock returns.

JEL Classification: G11, G12, G14

Suggested Citation

Stein, Jeremy C., Rational Capital Budgeting in an Irrational World. J. OF BUSINESS, Vol. 69 No. 4, October 1996, Available at SSRN: https://ssrn.com/abstract=8034

Jeremy C. Stein (Contact Author)

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States
617-496-6455 (Phone)
617-496-7352 (Fax)

HOME PAGE: http://post.economics.harvard.edu/faculty/stein/stein.html

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Do you have negative results from your research you’d like to share?

Paper statistics

Abstract Views
2,138
PlumX Metrics