Seminario académico interno: "Which projects do CFOs receive after pre-announcing their Cost of Capital?"

23 de Junio, 13:00 horas. Sala T601.

Expone: Rodrigo Wagner

Abstract:
Capital budgeting is the process of allocating resources to projects of positive NPV. In practice, this is usually made by pre-announcing a rule in which projects above a given hurdle rate of return are accepted and those below are rejected. Some existing theories point out a possible gaming of this rule by the units preparing projects, which want their projects executed. But empirically, financial economics have had a hard time analyzing this essential activity of practical financial management. This is for example because of aspects like data privacy of these projects and/or to sample size. In this paper we use more than 15,000 projects evaluated according to a standard Internal Rate of Return (IRR) methodology between 2001- 2017. This is a period in which also the hurdle rate for approval changed. We find the following stylized facts. First, there are few projects submitted below the hurdle rate, consistent with a cost of preparing a project. Second and most important, we find evidence of an abnormal amount of projects just above the hurdle rate (bunching). Moreover, as the pre-announced hurdle rate was lowered over time, so did the bunching of projects, exactly above the new cutoffs. This is consistent with a causal interpretation, from cutoff announcement to bunching of projects, and not the other way around. Third, for some years projects tend also to bunch close to the old hurdle rate, consistent with lag in perceptions about the cutoff. We offer a simple model to explain those results and to think about the consequences of imposing different decision rules on capital budgeting.