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  5. Corporate Investment and Capital Budgeting
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Corporate Investment and Capital Budgeting

Paper Session

Saturday, Jan. 7, 2023 8:00 AM - 10:00 AM (CST)

Sheraton New Orleans, Napoleon B & C
Hosted By: American Finance Association
  • Chair: Rohan Williamson, Georgetown University

On a Spending Spree: The Real Effects of Heuristics in Managerial Budgets

Paul Decaire
,
Arizona State University
Denis Sosyura
,
Arizona State University

Abstract

Using micro data on managerial expenditures, we uncover heuristics in capital budgets, such as nominal rigidity, anchoring, and sharp reset deadlines. Such heuristics engender managerial opportunism and erode investment efficiency. Managers with a budget surplus increase investment sharply before budget deadlines, and such investments yield lower sales, weaker margins, and more negative NPV projects. Managers who reach a budget constraint early in the fiscal cycle halt further spending until their budget is reset, irrespective of investment options. These effects are stronger at firms with more hierarchical layers and a greater subordinates-to-executives ratio. Overall, simplifying budgeting rules engender strategic behavior and wasteful spending.

The Horizon of Investors' Information and Corporate Investment

Olivier Dessaint
,
INSEAD
Thierry Foucault
,
HEC Paris
Laurent Fresard
,
USI Lugano and Swiss Finance Institute

Abstract

We study how the quality of investors’ information across horizons influences investment. In our theory, managers care about how investment is impounded in current stock prices. Because prices imperfectly reflect investment’s value, they under-invest. However, they under-invest less when investors have better information about the horizon matching that of their projects. Using a measure of projects’ horizon obtained from the text of regulatory filings, we find that improvements in investors’ long-term (short-term) information induce firms with long-term (short-term) projects to invest more, especially when managers focus on current stock prices. Therefore, the quality of investors’ information across horizons has real effects.

Do Buffers Destroy Firm Value? The Role of the Hurdle Rate in Project Development

John Barry
,
Duke University
Bruce Carlin
,
Rice University
Alan Crane
,
Rice University
John Graham
,
Duke University

Abstract

Nearly eighty percent of CFOs use hurdle rates that exceed their true costs of capital by an average of 6.6 percentage points. Extant research proposes several frictions that lead to the hurdle rate buffer, but does not address why a market or governance solution has not evolved to remedy a friction that might appear to destroy value. We develop a theoretical model of delegated bargaining that shows that hurdle rate buffers convey a bargaining advantage over counterparties during project development; and, using buffers may create firm value, even though marginal, positive NPV projects get discarded. The model’s key insights are that adopting projects changes the boundary of the firm and that the price of inputs and upfront costs are endogenously set by bargaining with counterparties. We use CFO survey data to empirically characterize buffer usage and examine predictions from the model.

Discussant(s)
Elisabeth Kempf
,
Harvard Business School
Philipp Krueger
,
University of Geneva and Swiss Finance Institute
Wei Jiang
,
Emory University
JEL Classifications
  • G0 - General
  • G3 - Corporate Finance and Governance