Table of Contents
ISRN Economics
Volume 2012 (2012), Article ID 478485, 4 pages
http://dx.doi.org/10.5402/2012/478485
Research Article

Correcting for Hubris in Project Appraisal

School of Business & Economics, Wilfrid Laurier University, Waterloo, ON, Canada N2L 3C5

Received 18 April 2012; Accepted 28 May 2012

Academic Editors: A. Rodriguez-Alvarez and B. M. Tabak

Copyright © 2012 Jacques A. Schnabel. This is an open access article distributed under the Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.

Abstract

Behavioral finance research stresses the prevalence of overconfidence in capital budgeting practices. To remedy this shortcoming, specifically the upward bias in cash flow forecasts, the extant literature emphasizes the reduction of such forecasts. This paper considers the conditions under which a different adjustment is warranted, namely, an upward correction in the hurdle rate employed to evaluate the project. It is argued here that if adverse events can have a long-term, versus a merely transitory, deleterious effect on the project's cash flows, the second adjustment is appropriate.