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Economists often portray corporate executives as highly strategic decision-makers who carefully select investments based on thorough analysis. However, the reality is more complex. Despite low interest rates in the 2010s, investment in the US and Britain did not see a significant increase. Even as interest rates have risen, investment has remained stable, puzzling economists. Sticky hurdle rates, which are slow to adjust, may offer an explanation for this phenomenon.
A recent blog by Bank of England economists revealed that executives have been slow to adjust hurdle rates, even as interest rates have increased. This reluctance to change hurdle rates has dampened the impact of monetary policy on investment. Companies that did raise their hurdle rates in response to tighter monetary policy reported a decrease in investment.
Research by academics also indicates that hurdle rates have remained stagnant in the face of changing economic conditions. This conservative approach by executives has led to a lack of investment, with hurdle rates acting as a barrier to potential projects. The reluctance to adjust hurdle rates may stem from a desire to demonstrate prudence to investors or could be a result of internal decision-making dynamics within companies.
Overall, executives’ cautious approach to investment decisions, influenced by factors like market concentration and competition, highlights the complexity of corporate decision-making. While the logic behind investment decisions may not always align with traditional economic theories, it is clear that managers are aware of changes in their cost of capital. The interplay of various factors within companies ultimately shapes their investment strategies.
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