Corporate Discount Rates

Niels Gormsen and Kilian Huber

No 18221, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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: Corporate investment; Discount rate; Cost of capital; required return to capital; market power; Risk (search for similar items in EconPapers)
JEL-codes: E22 E32 E43 E44 E52 G10 G12 G30 G31 G40 (search for similar items in EconPapers)
Date: 2023-06
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