Sticky hurdles: the dynamics of firm hurdle rates in a tightening cycle

Many firms use required rates of return on investment – or hurdle rates – to evaluate the attractiveness of their investment projects. This paper examines the adjustment of these hurdle rates to a tightening in monetary policy. Using new survey evidence from the 2022–23 hiking cycle, we find that hurdle rates for UK firms tend to be high and that they responded sluggishly to increases in interest rates over this period. Firms who use external finance to fund investment were more likely to have adjusted their hurdle rates in response to higher interest rates; but even for these firms, only around half of the increase in cost of capital was passed into hurdle rates. Using high-frequency monetary policy shocks over a longer period of time, we show that firms with sticky hurdle rates reduce investment by less in response to contractionary policy shocks than firms that update their hurdle rates more frequently.