Value maximizing hurdle rates for R&D investment

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Abstract:

We show that the value maximizing hurdle rate for research and development (R&D) investments among private firms operating in a market setting is less than for conventional investments despite the fact that R&D has development risk. Because development risk arises only during R&D, entrepreneurs control this risk by deferring or pursuing R&D depending upon profitability. This risk management moderates downside loss and encourages upside gain which increases the value attraction of R&D and decreases the value maximizing hurdle rate below that of conventional investment.

Keywords: R&D; Tobin's q; hurdle rates; real options

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/10438590903003631

Affiliations: 1: Faculty of Business Administration, Simon Fraser University, Vancouver, BC, Canada 2: The Wharton School, University of Pennsylvania, Philadelphia, PA, USA

Publication date: November 1, 2010

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