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The WACC Fallacy: The Real Effects of Using a Unique Discount Rate

Philipp Krueger

University of Geneva; University of Geneva - Geneva Finance Research Institute; Swiss Finance Institute

Augustin Landier

Toulouse School of Economics

David Thesmar

HEC Paris - Finance Department

February 18, 2011

Journal of Finance, Forthcoming
AFA 2012 Chicago Meetings Paper

We provide evidence that firms fail to properly adjust for risk in their valuation of investment projects, and that this behavior leads to value-destroying investment decisions. If managers tend to use a single discount rate within firms, we expect conglomerates to underinvest in relatively safe divisions, and to overinvest in risky ones. We measure division relative risk as the difference between the division market beta and a firm-wide beta. We establish a robust and significant positive relationship between division-level investment and division relative risk. Then, we measure the value loss due to this behavior in the context of acquisitions. When the bidder's beta is lower than that of the target, announcement returns are lower by 0.8% of the bidder's equity value.

Number of Pages in PDF File: 62

Keywords: capital budgeting, cost of capital, behavioral finance, investment

JEL Classification: G11, G31, G34

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Date posted: February 21, 2011 ; Last revised: July 18, 2014

Suggested Citation

Krueger, Philipp and Landier, Augustin and Thesmar, David, The WACC Fallacy: The Real Effects of Using a Unique Discount Rate (February 18, 2011). Journal of Finance, Forthcoming; AFA 2012 Chicago Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1764024 or http://dx.doi.org/10.2139/ssrn.1764024

Contact Information

Philipp Krueger
University of Geneva ( email )
102 Bd Carl-Vogt
Genève, CH - 1205
University of Geneva - Geneva Finance Research Institute ( email )
Swiss Finance Institute ( email )
c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Augustin Landier
Toulouse School of Economics ( email )
Place Anatole-France
Toulouse Cedex, F-31042
David Thesmar (Contact Author)
HEC Paris - Finance Department ( email )
1 rue de la Liberation
Jouy-en-Josas Cedex, 78351
+33 1 39 67 94 12 (Phone)
HOME PAGE: http://www.hec.fr/hec/eng/professeurs_recherche/p_liste/p_fiche.php?num=135

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