Incentive Properties of Residual Income When There is an Option to Wait
AbstractPerformance measures based on residual income are increasingly popular. The academic lit-erature shows that residual income has important incentive properties when management bases investment decisions on the net present value (NPV) rule. My analysis focuses on the case in which investment decisions can be postponed, when management must extend the simple NPV rule by considering an option value. My analysis shows that some important in-centive properties of residual income still hold when there is an option to wait, but only when the residual income measure is correctly adjusted. I also provide an incentive-based explana-tion of why the capital charge rate within firms is often significantly higher than the firm's cost of capital.
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Bibliographic InfoArticle provided by LMU Munich School of Management in its journal Schmalenbach Business Review.
Volume (Year): 57 (2005)
Issue (Month): 1 (January)
Depreciation Methods; Hurdle Rates; Performance Measure; Real Options; Residual Income.;
Find related papers by JEL classification:
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
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- Magni, Carlo Alberto, 2009.
"Splitting up value: A critical review of residual income theories,"
European Journal of Operational Research,
Elsevier, vol. 198(1), pages 1-22, October.
- Carlo Alberto, Magni, 2008. "Splitting Up Value: A Critical Review of Residual Income Theories," MPRA Paper 10506, University Library of Munich, Germany.
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