Why do firms use high discount rates?

We present evidence consistent with operational constraints leading firms to use high discount rates that average twice the firms’ cost of financial capital. Based on a survey of Chief Financial Officers matched to archival data, we find that firms with abundant access to capital but limited qualifi...

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Bibliographic Details
Published in:Journal of financial economics 2016-06, Vol.120 (3), p.445-463
Main Authors: Jagannathan, Ravi, Matsa, David A., Meier, Iwan, Tarhan, Vefa
Format: Article
Language:English
Subjects:
Balance sheets
Capital budgeting
Cost of capital
Discount rates
Management theory
Profitability
Studies
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Summary:We present evidence consistent with operational constraints leading firms to use high discount rates that average twice the firms’ cost of financial capital. Based on a survey of Chief Financial Officers matched to archival data, we find that 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 that use high discount rates have strong balance sheets, low leverage, and large cash holdings. In addition, firms appear to increase discount rates to account for idiosyncratic risk.
ISSN:0304-405X
1879-2774
DOI:10.1016/j.jfineco.2016.01.012