Hurdle rates vs. WACC

The four post-2000 data points suggest that the average corporate hurdle rate has been quite stable for at least ten years, showing no evidence of a downward shift in concert with the general decline in interest rates over this period. Indeed, in the 2003 survey study, more than half of the respondents claimed that they had not changed their hurdle rate in the three years leading up to the survey, suggesting the recent prevailing level extends back at least to 2000. The results from two earlier surveys indicate that the average hurdle rate was about 2% higher in the 1980s and early 1990s. Even so, the difference pales in comparison to the 8 percentage point drop in interest rates between mid-1985 and 2012; moreover, the median and modal responses appear to be unchanged or close to unchanged over the entire period. The fact that the mode has been a constant 15% throughout the entire period suggests that hurdle rates are determined using rough rules of thumb, rather than fine-tuned calculations, an interpretation that would account for the lack of sensitivity to interest rates reported by vast majority of the firms in our study. [Link]

So much for studying Weighted Average Cost of Capital (WACC)!

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2 thoughts on “Hurdle rates vs. WACC

  1. Thank you for this link.

    Needs to read slowly and again. This is something similar to what I said in response to your blog post in which you proposed that RBI front load interest rate reductions and get done with it now. I had mentioned that the effect of such an interest rate reduction would not be of much use to spur investment.

    I now think that unless one has 10 + years of business experience, one should not take up study of economics at all. An academic economist now seems to be generally toxic. What Keynes and Bagehot (and perhaps JP Morgan) had proposed to overcome systemic shocks in case of bank runs and distress due to such bank run(s) to the overall banking system was clearly a short term measure.

    It has been stretched to such an extent — thanks to liberal reinterpretations of Keynes’ theory on Govt spending & demand — that permanent low interest rates are a feature of many many countries. Most Govt.s are bankrupt if seen from the liabilities and contingent liabilities on their Balance Sheets – the population that underpins a currency is not any longer as productive – and are now expecting to live off their savings (ephemeral now?) and uncontracted obligations of their Govt.s (which will have to be legislated away if the Govt.s have to remain solvent).

    May be we will still be alright. Our children? I am not as old as Jeremy Grantham, but no one else makes sense really to me.

    If I can let a bunch of economists can be allowed to determine how much I can earn on my savings and also on my purchasing power (and my kids future) by reading the stars, we are morally bankrupt.

    Thanks

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    1. I went back and read that comment of yours and my response to it. I noted your comments then and now. I remain satisfied with my response. We should not forget that interest rates might not spur investment in India, with bankers still grappling with NPA and corporations with their bloated balance sheets although I do recall S&P research that the top 100 corporations in India have much lower (mean, median and mode) Debt/EBITDA ratios than those in China. Of course, that is neither here nor there. In any case, rate cuts could spur consumption spending, particularly since they might be somewhat more constrained by the relatively deficient monsoon, particularly in rural India. A 50-basis point rate cut might help spur some consumption.

      Incidentally, I did catch up – yet again – with the FT Alphaville post that you had recommended back then in May. It fails to note one point. All the discussion about central banks and their transmission to credit creation and demand is pointless if the reality is more in line with the endogenous theory of money whereby credit creates money (reserves) and not the other way around. A Bank of England discussion paper published in March 2014 gave the official imprimatur to the Endogenous theory of money.

      Nonetheless, the last paragraph of that blog post by Matthew Klein is rather interesting:

      The most significant takeaway of all this is that the connection between monetary policy and the real economy, while significant, continues to change in ways that nobody, including the experts, can fully understand. Remember this whenever you hear that a given policy change is “obviously” right/wrong/necessary etc. There’s nothing obvious about any of this.

      A timely reminder to Lloyd Blankfein and to John Authers who are the latest to join the chorus against a Fed rate hike later today. FT must be embarrassed to be leading the campaign against a Fed rate hike with nary an alternate point of view.

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