The Effects of Suboptimal Investment Rules on Value

This study evaluates optimal investment rules under various stochastic processes and investigates the cost of adopting suboptimal investment rules to firm value. It is found that with consideration of the effects of preemptive competition or mean reversion, optimal investment trigger is lower than that under a geometric Brownian motion (GBM) process. Therefore, acknowledging option to wait, under the underlying GBM assumption, unnecessarily delays corporate investment. The study also proposes a loss function to measure the costs of adopting suboptimal investment rules. The main finding is that the best investment rule is the optimal investment rule itself. Any deviation from the optimal investment rule is suboptimal and may lead to a substantial loss in value.