Optimal Capital Allocation Using RAROC(tm) and EVA

Josef Zechner and Neal Stoughton

No 4169, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This Paper analyses firms? capital allocation decisions when optimal capital structure is linked to the risk of underlying assets and when equity capital is costly and cannot be raised instantaneously. In the model, division managers receive private information and authority is delegated to them over risky project choices. The optimal mechanisms are related to EVA compensation and RAROC performance measurement systems. In the optimal mechanism, position limits will be employed but are not always completely utilized. Hurdle rates reflect capital allocation through a division-specific capital structure. In the multidivisional context the optimal capital allocation mechanism incorporates valuable externalities leading to overall firm EVA maximization.

Keywords: Financial institutions; Banking; Capital budgeting; Investment policy (search for similar items in EconPapers)
JEL-codes: G20 G21 G30 G31 (search for similar items in EconPapers)
Date: 2004-01
New Economics Papers: this item is included in nep-cfn, nep-fin and nep-mac
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Citations: View citations in EconPapers (3)

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Related works:
Journal Article: Optimal capital allocation using RAROC(TM) and EVA(R) (2007)
Working Paper: Optimal Capital Allocation Using RAROC And EVA (1999)
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