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The Effects of Return on Investment and Residual Income Measures on Risk-Taking in Capital Investment Decisions

We conduct an experiment to examine the separate and interactive effects of individuals’ risk preferences and two commonly-used performance measures – return on investment (ROI) and residual income (RI) – on risk-taking in capital investment decisions. We predict and find that the use of ROI as a performance measure leads to riskier choices as compared to RI, and that this effect is concentrated in relatively more risk-averse individuals. We also provide process evidence that reveals some of the ways in which ROI and RI performance measures affect decision making. Collectively, our results contribute to literature examining the effects of accounting information and performance measures on managers’ risk-taking behaviors.