This chapter was intended as a first cut at the problem of capital budgeting
in an inefficient market, and, as such, it leaves many important questions
unanswered.There are at least three broad areas where further researchmight
be useful. First, there are the pragmatic risk-measurement issues raised in sec-
tion 4, namely, just how well do stock return β’s actually reflect the funda-
mental riskiness of underlying firm cash flows? Are stock return β’s more
informative about fundamental risk for some classes of companies than for
others? Does lengthening the horizon over which returns are computed
help matters? Here it would clearly be desirable to update and build on
some of the work done in the 1970s.
Second, as discussed in section 5, there is potentially quite a bit more that
can be done in terms of refining and extending the basic conceptual frame-
work. And finally, as seen in section 6, the theory developed here gives rise
to some new empirical implications, having to do with cross-sectional dif-
ferences in the intensity of the relationship between stock prices and corpo-
rate investment.
RATIONAL CAPITAL BUDGETING 629