Abstract
This paper considers two paradoxes concerning the relationship between capital investment decisions and competition. First, conventional capital budgeting methods imply that substantial infra-marginal surpluses are attained above the cost of capital, but this is inconsistent with the premise that returns on capital equal the cost of capital in competitive markets. Second, contrasts in the pharmaceutical industry between high reported returns on capital invested, the accounting treatment of research and development outlays, and inter-firm competition in research and development are explored.
Notes
1. For possible complications, see Hirshleifer (Citation1970, 51–56).
2. To be sure, very high internal rates of return are rarer than those at the right-hand side of Dean’s diagram. But they are hardly nonexistent. I once analyzed the complete capital investment portfolio of a large US industrial corporation. I found numerous projects expected to yield more than 100%.
3. In fact, profit returns on farmers’ net worth for US agriculture are remarkably low. See Scherer (Citation1996, 29). Later data reveal returns on farm equity between 1997 and 2001 averaging 4.6% with government subsidies included and 2.6% without subsidies.
4. Equipment purchasers appear to realize substantially higher rates of return on their purchases, inferred from productivity growth rates, than the original equipment sellers. This implies the existence of significant externalities, which would not be capitalized or obscured by capitalization. See Scherer (Citation1982).
5. Analogous capitalization of R&D in the gross domestic product accounts was adopted by the United States in August 2013, leading to a one-time reported GDP jump.
6. Except in the forward shifting of tax savings under current costing of R&D, internal rate of return profiles should not be distorted when Joel Dean-like capital rationing analyses are conducted.
7. An historical point: Barzel and I have subsequently agreed that his mathematical formulation was first suggested by me in Scherer (Citation1967, n. 11) and presented at a 1966 seminar in which Barzel participated. Barzel’s model was formulated before the time of the seminar. Thus, the “inventions” were presumably parallel and simultaneous.