Abstract
We present evidence consistent with operational constraints leading firms to use high discount rates that average twice the firms' cost of financial capital. Based on a survey of Chief Financial Officers matched to archival data, we find that firms with abundant access to capital but limited qualified management or manpower appear to forgo profitable projects in preparation for more profitable future investment opportunities. Consistent with this explanation, firms that use high discount rates have strong balance sheets, low leverage, and large cash holdings. In addition, firms appear to increase discount rates to account for idiosyncratic risk.
| Original language | English (US) |
|---|---|
| Pages (from-to) | 445-463 |
| Number of pages | 19 |
| Journal | Journal of Financial Economics |
| Volume | 120 |
| Issue number | 3 |
| DOIs | |
| State | Published - Jun 1 2016 |
Funding
We thank Arjun R. Kannan for valuable research assistance and John R. Graham and Alexander Ljungqvist for sharing their estimates of marginal tax rates and earnings response coefficients, respectively. This project would not have been possible without the guidance and support of Donald Jacobs. We are grateful to Vikas Agarwal, Douglas R. Emery, Jose Liberti, Deborah Lucas, Bob McDonald, Hariom Manchiraju, Kevin Andrew Mullally, Tim Thompson, Baozhong Yang, an anonymous referee, and seminar participants at Georgia State University, Shanghai Advanced Institute of Finance, University of Iowa, University of Miami, University of New South Wales, and University of Pennsylvania for helpful comments. We gratefully acknowledge support from both the Financial Institutions and Markets Research Center and the Zell Center for Risk Research at the Kellogg School of Management, Northwestern University.
Keywords
- Capital budgeting
- Cost of capital
- Discount rates
ASJC Scopus subject areas
- Accounting
- Finance
- Economics and Econometrics
- Strategy and Management