Why Do Firms Use High Discount Rates?
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)
HEC Montreal - Department of Finance
Loyola University of Chicago - School of Business Administration; Northwestern University - Kellogg Graduate School of Management
June 29, 2015
We find that operational constraints lead firms to use high discount rates that exceed their cost of financial capital, based on an original survey of CFOs with firm identifiers linked to responses. 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 using high discount rates have strong balance sheets, low leverage, and large cash holdings. We conclude that operational constraints rather than financial constraints explain why firms use discount rates that are on average twice their cost of financial capital.
Number of Pages in PDF File: 83
Keywords: Capital budgeting; discount rates; cost of capital
JEL Classification: G31; G32
Date posted: March 22, 2014 ; Last revised: June 30, 2015
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