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The WACC Fallacy: The Real Effects of Using a Unique Discount Rate

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  • PHILIPP KRÜGER
  • AUGUSTIN LANDIER
  • DAVID THESMAR

Abstract

type="main"> In this paper, we test whether firms properly adjust for risk in their capital budgeting decisions. If managers use a single discount rate within firms, we expect that conglomerates underinvest (overinvest) in relatively safe (risky) divisions. We measure division relative risk as the difference between the division's asset beta and a firm-wide beta. We establish a robust and significant positive relationship between division-level investment and division relative risk. Next, we measure the value loss due to this behavior in the context of acquisitions. When the bidder's beta is lower than that of the target, announcement returns are significantly lower.

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  • Philipp Krüger & Augustin Landier & David Thesmar, 2015. "The WACC Fallacy: The Real Effects of Using a Unique Discount Rate," Journal of Finance, American Finance Association, vol. 70(3), pages 1253-1285, June.
    • Handle: RePEc:bla:jfinan:v:70:y:2015:i:3:p:1253-1285
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance

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