Title: The Strategic Role of 'Cost of Capital' in Residual Income Measurement
Abstract: This paper examines the strategic role of "cost of capital" in residual income measurement in an oligopoly. Because of imperfect competition in the product market, firm market valuation and managerial performance evaluation based on residual income measures or Economic Value Added (EVA) are most closely related to each other so that an interactive effect arises. Facing a stochastic production-technology with diminishing marginal returns in the decision context of capital investment, firm owners can use the "cost of capital" in residual income measures as a competitive tool for their managers. We show that the mode of competition (i.e., Cournot versus Bertrand) has a significant impact on the strategic role, and determines whether the firm owners levy a lower or higher "cost of capital" on their managers than their own opportunity cost of capital. They will charge the managers with their own cost of capital if, and only if, their managers' actions do not cause their competitors to counteract so that the firm's market value is affected (i.e., price-takers in perfect competition or price-setters in monopoly). Consequently, imperfect competition separates the capital's ownership and management, and perfect competition or monopoly unites the two.
Publication Year: 2000
Publication Date: 2000-01-01
Language: en
Type: article
Indexed In: ['crossref']
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