Are Real Investment Decisions Based on Risk Adjusted Performance Measures Consistent with Maximizing Shareholder Value?

Abstract

We show that the usage of risk adjusted performance measures (RAPM), such as the RORAC or the RARORAC, as decision criterion for real investment decisions might favor projects that do not maximize shareholder value for project selection of mutually exclusive projects. We find that RAPM based on the CVaR are in general more consistent with the NPV-criterion than RAPM based on the VaR. In addition, measures that are based on the relative (C)VaR are more consistent with the NPV-criterion than measures based on the absolute (C)VaR. Overall we find that the RARORAC based on the relative (C)VaR outperforms all evaluated RAPM in this context.

Keywords: risk management, risk adjusted performance measures, RORAC, RARORAC, shareholder value, VaR, CVaR

JEL Classification: D92, G31, G32