search query: @author Feltham, G. A. / total: 4
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| Author: | Christensen, P. O. Feltham, G. A. Wu, M. G. H. |
| Title: | Cost of Capital in Residual Income for Performance Evaluation |
| Journal: | Accounting Review
2002 : JAN, VOL. 77:1, p. 1-23 |
| Index terms: | COSTS CAPITAL ACCOUNTING |
| Language: | eng |
| Abstract: | The authors consider a setting in which a firm uses residual income to motivate a manager's investment decision. Textbooks often recommend adjusting the residual income capital charge for market risk, but not for firm-specific risk. The authors demonstrate two basic flaws in this recommendation. First, the capital charge should not be adjusted for market risk. Charging a market risk premium results in "double" counting because a risk-averse manager will personally consider this risk. Second, while investors can avoid firm-specific risk through diversification, a manager cannot. If the manager faces significant firm-specific risk at the time he makes his investment decision, then it is optimal to charge him less than the riskless return so as to partially offset his reluctance to undertake risky investments. |
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