MIT Sloan Management Review

Financial Management

 

A CEO Survey of U.S. Companies’ Time Horizons and Hurdle Rates

By James M. Poterba and Lawrence H. Summers

October 15, 1995

ASURVEY OF CEOS AT FORTUNE 1,000 FIRMS ASKED ABOUT THEIR FIRMS’ HURDLE RATES AND TIME HORIZONS. SURVEY RESULTS SUGGEST THAT MOST U.S. FIRMS use hurdle rates that are higher than standard cost-of-capital analyses would suggest. The average discount rate applied to constant-dollar cash flows was 12.2 percent, distinctly higher than equity holders’ average rates of return and much higher than the return on debt during the past half-century. At the time of the survey, the fall of 1990, U.S. CEOs believed that their firms had systematically shorter time horizons than their major competitors in Europe and (especially) Asia. U.S. CEOs also thought that government policy is a powerful agent affecting corporate planning horizons. They saw several policy reforms, including a cut in corporate tax rates, a permanent R&D tax credit, a corporate tax deduction for dividend payments, and a credible commitment to a stable tax policy for the next decade, as policies that could lengthen planning horizons.

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The competitiveness of U.S. corporations, particularly manufacturing firms, declined during the 1980s. The decade witnessed serious inroads by foreign firms into traditional domestic markets. In capital goods, for example, the import penetration ratio rose from less than 15 percent to nearly 40 percent. Some indicators of U.S. competitiveness have stabilized or shown some improvement in the first half of the 1990s, largely as a result of exchange rate movements and a strong U.S. macroeconomy. However, the productivity of foreign manufacturers, notably those in Japan, has grown faster than that of U.S. firms for more than two decades.1 This trend suggests that foreign corporations will continue to present stiff challenges to U.S. firms in the years ahead.

Many explanations have been advanced for the decline in U.S. industrial competitiveness during the 1980s. They frequently assign a central role to differences in the willingness of U.S. and foreign firms to forgo short-term returns in favor of long-term rewards. These differences in “time horizons” can manifest themselves in differences in R&D, plant, and equipment investment; training for workers with firm-specific skills; and willingness to undertake long-term market development programs. The interest in corporate time horizons has generated a lively academic and policy debate about the cost of capital facing firms in different nations. The cost of capital is an important component of the discount rate... To read the complete article, login or sign-up using the form below.

 
 

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