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Capital Budgeting For EPS Maximizers

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  • Itzhak Ben-David
  • Alex Chinco

Abstract

To increase a company’s earnings, a project must generate enough income next year to pay for its own financing. Hence, a manager who wants to maximize her EPS (earnings per share) should only invest in accretive projects that have income yields above the firm’s cheapest financing option. This is the max EPS analog to the positive-NPV (net present value) rule. Maximizing EPS ≠ minimizing investment. EPS maximizers use real investment to arbitrage between asset and capital markets. This framework rationalizes the pervasive use of IRRs (internal rates of return) and payback periods. An IRR effectively measures how accretive a project will be. A payback period expresses the project’s income yield as a multiple. Empirically, a simple max EPS model explains M&A payment method and investment-cash flow sensitivity. It also predicts which firms have higher proportions of convertible debt and capitalized interest expense.

Suggested Citation

  • Itzhak Ben-David & Alex Chinco, 2025. "Capital Budgeting For EPS Maximizers," NBER Working Papers 34061, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:34061
    Note: AP CF
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    JEL classification:

    • D03 - Microeconomics - - General - - - Behavioral Microeconomics: Underlying Principles
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • J33 - Labor and Demographic Economics - - Wages, Compensation, and Labor Costs - - - Compensation Packages; Payment Methods
    • L21 - Industrial Organization - - Firm Objectives, Organization, and Behavior - - - Business Objectives of the Firm
    • M41 - Business Administration and Business Economics; Marketing; Accounting; Personnel Economics - - Accounting - - - Accounting

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