Abstract

http://ssrn.com/abstract=2412250
 


 



Why Do Firms Use High Discount Rates?


Ravi Jagannathan


Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER); Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF); Indian School of Business (ISB), Hyderabad

David A. Matsa


Northwestern University - Kellogg School of Management; National Bureau of Economic Research (NBER)

Iwan Meier


HEC Montreal - Department of Finance

Vefa Tarhan


Loyola University of Chicago - School of Business Administration; Northwestern University - Kellogg Graduate School of Management

June 8, 2014


Abstract:     
We find that firms use discount rates for capital budgeting that are on average twice their cost of financial capital, based on an original survey of CFOs with firm identifiers linked to responses. Under the standard corporate finance paradigm, firms take all projects that return more than their cost of financial capital unless they are constrained. We explore the nature of the constraints that lead firms to increase their discount rates. Firms that use high discount rates relative to their cost of financial capital have strong balance sheets, low leverage, and large cash holdings. These firms appear to be conserving managerial bandwidth and manpower by forgoing good projects while preparing for even better investment opportunities to arise. This is consistent with their response that they are facing operational constraints but not financial constraints. CAPM and WACC explain the cross-section of discount rates after we control for limited managerial bandwidth.

Number of Pages in PDF File: 78

Keywords: Capital budgeting; discount rates; cost of capital

JEL Classification: G31; G32

working papers series





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Date posted: March 22, 2014 ; Last revised: June 9, 2014

Suggested Citation

Jagannathan, Ravi and Matsa, David A. and Meier, Iwan and Tarhan, Vefa, Why Do Firms Use High Discount Rates? (June 8, 2014). Available at SSRN: http://ssrn.com/abstract=2412250 or http://dx.doi.org/10.2139/ssrn.2412250

Contact Information

Ravi Jagannathan
Northwestern University - Kellogg School of Management ( email )
2001 Sheridan Road
429 Andersen Hall
Evanston, IL 60208
United States
847-491-8338 (Phone)
847-491-5719 (Fax)
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )
Shanghai
China
Indian School of Business (ISB), Hyderabad ( email )
Hyderabad, Gachibowli 500 019
India

David A. Matsa (Contact Author)
Northwestern University - Kellogg School of Management ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
847-491-8337 (Phone)
847-491-5719 (Fax)
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Iwan Meier
HEC Montreal - Department of Finance ( email )
3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7 H2J 2K9
Canada
(514) 340-3198 (Phone)
Vefa Tarhan
Loyola University of Chicago - School of Business Administration ( email )
820 North Michigan Avenue
Chicago, IL 60611
United States
Northwestern University - Kellogg Graduate School of Management ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
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