Corporate Discount Rates

86 Pages Posted: 2 Aug 2022 Last revised: 17 Sep 2023

See all articles by Niels Joachim Gormsen

Niels Joachim Gormsen

University of Chicago - Booth School of Business

Kilian Huber

University of Chicago - Booth School of Business

Date Written: August 2, 2022

Abstract

Standard theory implies that the discount rates used by firms in investment decisions (i.e., their required returns to capital) determine investment and transmit financial shocks to the real economy. However, there exists little evidence on how firms' discount rates change over time and affect investment. We construct a new global database based on manual entry from conference calls. We show that, on average, firms move their discount rates with the cost of capital, but the relation is far below the one-to-one mapping assumed by standard theory, with substantial heterogeneity across firms. This pattern leads 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. Future investment is negatively related to discount rate wedges, but more weakly related to the cost of capital because of the limited transmission into discount rates. Moreover, the large and growing discount rate wedges can account for the puzzle of "missing investment" (relative to high asset prices) in recent decades. We find that beliefs about value creation combined with market power, along with fluctuations in risk, explain changes in discount rate wedges over time.

Keywords: discount rates, cost of capital, investment, financial markets, Tobin's Q, risk, market power

JEL Classification: E22, E32, E43, E44, E52, G10, G12, G30, G31, G40

Suggested Citation

Gormsen, Niels Joachim and Huber, Kilian, Corporate Discount Rates (August 2, 2022). Available at SSRN: https://ssrn.com/abstract=4160186 or http://dx.doi.org/10.2139/ssrn.4160186

Niels Joachim Gormsen (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

Kilian Huber

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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