FIGURE 3 The relationships among the cost of funds, the cost of capital, and corporate hurdle rates.

new investment projects above or below the cost of capital.9 Fully integrated international capital markets tend to equalize returns or costs at level A.

Because hurdle rates are set by managers, not capital markets, they are more difficult to measure than either the cost of funds or the cost of capital. Data are not plentiful apart from data on profit rates in the United States and Japan. Nevertheless, Hatsopoulos and Poterba develop important evidence on hurdle rates in their comparison of the rates of return earned by nonfinancial corporations in the United States and Japan.10 They find that since 1975 the operating returns of Japanese nonfinancial corporations have averaged only 5.2 percent whereas comparable U.S. companies’ returns have averaged 10.8 percent. This supports the view that average hurdle rates are lower in Japanese than in U.S. companies. These findings are corroborated by a survey of top executives in

9

See page 36 for an illustration of how the tax system affects the relationship between the cost of funds and the cost of capital.

10

George M. Hatsopoulos and James M. Poterba, “America’s Investment Shortfall: Probable Causes and Possible Fixes,” in the forthcoming companion volume.



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