How Do Firms Actually Use Hurdle Rates?

Based on research by John Barry (Rice Business), Bruce Carlin (Rice Business), Alan Crane (Rice Business), and John Graham (Duke)

Key findings:

• A hurdle rate is the minimum return a project must clear to receive approval.
• In finance classrooms, hurdle rates are typically taught as a decision-making tool for screening investment projects.
• But in practice, firms use them to shape negotiations during project development.

If you’ve taken a corporate finance class, you’re familiar with the logic behind investment decisions: a project creates value only if it earns more than the firm’s cost of capital.

To put that logic into practice, firms rely on a “hurdle rate” — the minimum return a project must clear to receive approval. If a firm’s hurdle rate is set at 15%, for example, a proposed investment expected to earn 14% may be rejected outright during evaluation.

According to new research, however, firms rarely use hurdle rates as neutral tools for making investment decisions. Rather, these rates are often set well above the cost of capital and play a more active role in how projects are negotiated, shaped and ultimately approved. 

A forthcoming article, co-authored by Rice Business professors John Barry, Bruce Carlin and Alan Crane, along with Duke professor John Graham, draws a sharp distinction between project evaluation and project development — a separation that rarely appears in finance models. 

In the finance classroom, costs and returns are treated as fixed inputs, and the hurdle rate is used to screen projects in or out (i.e., project evaluation). In practice, however, many investments take shape through negotiation. Prices, terms and even project scope are often still in flux as managers work with suppliers, customers or acquisition targets (i.e., project development). In that setting, the hurdle rate is no longer just a screening threshold; it becomes a constraint that shapes the bargaining process.

“The hurdle rate becomes a line in the sand,” Barry says. “Managers can point to it and say, ‘If we can’t clear this, we can’t do the project.’”

Drawing on surveys of CFOs, investment outcomes and merger data, the researchers show that elevated hurdle rates are not simply a conservative bias or departure from textbooks. Instead, they argue, high hurdle rates act as an internal commitment, shaping how firms negotiate with suppliers, partners and acquisition targets and often improving the firm’s share of value in the deals it pursues. 

Consider a firm developing a new production facility. In a textbook capital budgeting exercise, land, materials and construction are treated as fixed costs, and managers use a hurdle rate to evaluate whether the expected cash flows can justify them. In practice, however, those costs are not a given — they’re negotiated. When managers approach suppliers and landowners with a firm-wide hurdle rate in hand, the return threshold becomes a hard constraint; unless prices fall or terms improve, the project will not move forward. The hurdle rate, in other words, shapes the negotiation long before any spreadsheet delivers a final yes or no. 

“The hurdle rate becomes a line in the sand,” Barry says. “Managers can point to it and say, ‘If we can’t clear this, we can’t do the project.’”

To test this idea systematically, the researchers combine several sources of evidence. They draw on repeated surveys of CFOs to document how firms set hurdle rates and how persistent those thresholds are over time. They then link those stated rates to firm-level investment outcomes, examining how realized returns align with internal benchmarks. Finally, they analyze merger data to assess whether firms that use elevated hurdle rates secure different deal terms.

Taken together, the approach allows the researchers to connect what firms say about their investment rules, how managers act on those rules inside the firm, and what outcomes materialize in negotiation and deals. 

While much of the academic literature treats elevated hurdle rates as a distortion to be explained, this study focuses on how those rates function as a strategic commitment with real consequences for bargaining and firm value. 

“What we teach in finance classes is really only step one,” says Barry. “The next step in being a great finance practitioner is thinking beyond the spreadsheet — not that the models we teach are wrong, but rather how the assumptions and methods we use shape decisions and incentives both within and outside the organization.”

Forthcoming in Journal of Financial Economics, the paper suggests that capital budgeting is not just a matter of selecting projects, but of shaping the terms under which projects are developed and approved. Hurdle rates may screen investments in theory, but in practice they also discipline negotiations, anchor expectations and allocate bargaining power inside and outside the firm. 

For students in the finance classroom, the lesson is not to abandon the textbook framework, but to recognize that it is not rigid. Instead, such frameworks shape behavior and influence real outcomes. Understanding how these analytical tools operate within organizations — and how they guide choices long before a deal is ever signed — is part of what turns financial analysis into effective managerial practice.

Written by Scott Pett

Barry, Carlin, Crane, and Graham (2026). “Hurdle Rate Buffers and Bargaining Power in Asset Acquisition,” forthcoming in the Journal of Financial Economics.