Rational capital budgeting in an irrational world / Jeremy C. Stein Stein, Jeremy C

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Stein, Jeremy C
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The Journal of Business
Capital budget - Econometric models.; Financial management -- Research; Capital assets -- Management
This article addresses the following basic capital budgeting problem: 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, [5 can be useful as a capital budgeting tool, even if it is of no use in predicting stock returns.
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