Corporate Discount Rates

Abstract

Standard theory implies that the discount rates used by firms in investment decisions play a key role in determining investment and transmit shocks to asset prices and interest rates to the real economy. However, there exists little evidence on how corporate discount rates change over time and affect investment. We construct a new global database of firms' discount rates based on manual entry from earnings conference calls. We show that corporate discount rates move with the cost of capital, but the relation is less than one-to-one, leading to time-varying wedges between discount rates and the cost of capital. The average wedge has increased substantially over the last decades as the cost of capital has dropped. Discount rate wedges are negatively related to future investment, with a magnitude close to that predicted by theory. Moreover, the large and growing discount rate wedges can account for low investment (relative to high asset prices) in recent decades. We find that risk and the combination of market power and beliefs about value creation explain levels and trends of discount rate wedges.

Keywords: Discount rates, cost of capital, aggregate investment, missing investment, Tobin's Q

JEL Classification: E22, E44, E52, G10, G31