How bad can short termism be?—A study of the consequences of high hurdle discount rates and low payback thresholds

Survey evidence suggests that hurdle rates used in DCF analysis are often considerably in excess of any plausible estimate of firms’ cost of capital, and that top level decision makers often impose additional short payback thresholds. This paper focuses on the value loss that can arise under such ‘short termist’ decision criteria. It is shown that using such decision rules can help to protect the firm against the total value loss that can arise from the application of the naïve NPV decision rule, and that, for projects with growth prospects and/or moderate or greater volatility in future operating cash flows, the value loss (relative to ‘optimal decision-making’) which arises when firms impose fixed ‘short termist’ thresholds can be quite small.