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Incentive Properties of Residual Income When There is an Option to Wait

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  • Gunther Friedl

Abstract

Performance 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.

Suggested Citation

  • Gunther Friedl, 2005. "Incentive Properties of Residual Income When There is an Option to Wait," Schmalenbach Business Review (sbr), LMU Munich School of Management, vol. 57(1), pages 3-21, January.
  • Handle: RePEc:sbr:abstra:v:57:y:2005:i:1:p:3-21
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    Cited by:

    1. 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.
    2. Magni, Carlo Alberto, 2010. "Residual income and value creation: An investigation into the lost-capital paradigm," European Journal of Operational Research, Elsevier, vol. 201(2), pages 505-519, March.

    More about this item

    Keywords

    Depreciation Methods; Hurdle Rates; Performance Measure; Real Options; Residual Income.;

    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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