Capital Budgeting and Idiosyncratic Risk

67 Pages Posted: 17 Nov 2019 Last revised: 10 Jun 2021

See all articles by Paul H. Décaire

Paul H. Décaire

Arizona State University (ASU) - Finance Department

Date Written: June 9, 2021

Abstract

Using an NPV-based revealed-preference strategy, I find that idiosyncratic risk affects the discount rate that firms use in their capital budgeting decisions. I exploit quasi-exogenous within-region variation in project-specific idiosyncratic risk and find that firms inflate their discount rate in response to an increase in project-specific idiosyncratic risk. Moreover, these discount rate adjustments are negatively associated with measures of firm profitability and investment decision. I then explore how proxies for costly external financing and firm-level idiosyncratic risk diversification relate to discount rate adjustments. Consistent with theoretical predictions, firms appear to adjust their discount rate to account for both frictions.

Keywords: Capital Budgeting, Corporate Investment, Empirical Corporate Finance, Risk Management

JEL Classification: G30, G31, G32

Suggested Citation

H. Décaire, Paul, Capital Budgeting and Idiosyncratic Risk (June 9, 2021). Available at SSRN: https://ssrn.com/abstract=3480884 or http://dx.doi.org/10.2139/ssrn.3480884

Paul H. Décaire (Contact Author)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

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