Working Papers
9- Valuation Fundamentals (January 2024), with John Graham
[Draft coming soon]
We investigate a comprehensive sample of 78,509 equity reports to understand how professionals perform valuations. By directly observing measures of short- and medium-term growth expectations, terminal growth expectations, and subjective discount rates, we study the drivers of fluctuations in expected valuations. We find that both growth expectations and subjective discount rates play crucial roles. Our analysis reveals that subjective discount rates align with theoretical recommendations, track other professionals' estimates, and vary substantially over time, both in the aggregate and within firms. Subjective discount rates are unbiased predictors of firm-specific one-year future returns. Equity betas explain 29% more of the discount rate process than equity risk premia. The slope of the security market line obtained using subjective equity betas is steeper than the one estimated by the econometrician. Lastly, terminal growth rates respond to macroeconomic factors, such as monetary policies and GDP growth, but not to inflation.
8- What Drives Very Long-Run Cash Flow Expectations? (November 2023), with Marius Guenzel
- Best paper at the 2024 VSB Mid-Atlantic Research Conference
[SSRN Version]
Expectations of firms’ cash flows far into the future are central to corporate finance and asset pricing. Using a large, novel dataset on professional forecasters’ terminal growth rates (TGR) of firms that includes information about forecaster identities, allowing us to gather detailed personal backgrounds of forecasters, we establish key facts and identify drivers of their (very) long-run cash flow expectations. First, TGR expectations contain distinct economic information relative to other forecasting series, such as IBES long-term growth (LTG) forecasts which capture shorter, 3-5-year forecast horizons. Second, TGR expectations strongly and robustly predict realized long-run firm growth. Third, consistent with firm life cycle models, TGR expectations decline with firm age. Fourth, with the exception of very mature firms where a firm’s country and industry primarily account for the variation in TGRs, there exists large, persistent heterogeneity in TGR expectations across forecasters. Finally, compared to other settings (e.g., Giglio et al., 2021), forecaster demographics and backgrounds explain a larger part of the persistent heterogeneity in TGR expectations.
7- Resolving Estimation Ambiguity (March 2024), with Denis Sosyura and Michael Wittry
[Draft coming soon]
Economic models develop conceptual frameworks for fundamental decisions but rarely prescribe a specific estimation approach. Using novel data on the inputs and assumptions in professional stock valuations, we study how financial analysts address estimation uncertainty when calculating a firm’s cost of capital. Analysts use the same return-generating model (CAPM) but diverge in their estimation choices for key inputs, such as equity betas. Such estimation choices are driven by idiosyncratic analyst-specific criteria, persist throughout their career and across brokerages, and generate large cross-analyst variation in discount rates for the same stock. The dispersion in discount rates is associated with higher market measures of investor disagreement, such as trading volume. Overall, we provide micro evidence on how financial experts resolve estimation uncertainty.
6- On a Spending Spree: The Real Effects of Heuristics in Managerial Budgets (November 2023), with Denis Sosyura
Media mentions: Lebow School of Business News Letter, Chicago Business Review
[SSRN Version]
Using micro data on managerial expenditures, we uncover heuristics in capital budgets, such as nominal rigidity, anchoring, and sharp reset deadlines. Such heuristics engender managerial opportunism. Managers with a budget surplus increase investment before budget deadlines, and such projects underperform. Managers who reach a budget constraint early in the fiscal cycle halt spending until their budget is reset, irrespective of investment options. These effects are stronger at firms with more hierarchical layers and a greater subordinates-to-executives ratio. Such firms become targets of private equity funds. After the buyout by strong principals, firms remove budgetary heuristics and switch to continuous capital allocations. Overall, simplifying budgeting rules engender strategic managerial behavior.
5- Strategic Learning and Corporate Investment (August 2022), with Michael Wittry - R&R at The Journal of Finance
[SSRN Version]
We show that firms anticipate information spillover from peers' investment decisions and delay project exercise to learn from them. While this information improves project selection, the cost of waiting erodes these gains. To establish causality, we exploit local exogenous variation from the 1800s that shapes the number of peers that a firm can learn from today. The effect is most salient when information is scarce, costs of waiting are low, projects have low expected profitability, and the source information is more relevant. Finally, the anticipation of spillovers dampens aggregate investment, suggesting a role for this mechanism in macro-investment models.
4- Capital Budgeting and Idiosyncratic Risk (January 2024)
[SSRN Version]
- Best paper at the 2019 FRA Conference in Las Vegas
- Best Ph.D. paper at the 2019 FRA Conference in Las Vegas
- Cubist Systematic Strategies Ph.D. Candidate Award at the 2020 WFA Conference in San Francisco
Using an NPV-based revealed-preference strategy, I find that idiosyncratic risk affects the discount rate that firms use in their capital budgeting decisions. I exploit quasi-exogenous within-region variation in project-specific idiosyncratic risk and find that firms inflate their discount rate in response to an increase in project-specific idiosyncratic risk. Moreover, these discount rate adjustments are negatively associated with measures of firm profitability and investment decision. I then explore how proxies for costly external financing and firm-level idiosyncratic risk diversification relate to discount rate adjustments. Consistent with theoretical predictions, firms appear to adjust their discount rate to account for both frictions.
3- Self-Dealing in Corporate Investment (October 2022), with Denis Sosyura
* This paper previously circulated under the title CEO Pet Projects.
[SSRN Version]
- Best paper at the 2021 Raj & Kamla Gupta Governance Institute Conference (Drexel University)
- Top paper at the 2021 Global Finance Conference
- Best Paper at the 2021 International Corporate Governance Society Conference
Using hand-collected data on CEOs’ personal assets, we find that CEOs prioritize corporate investment projects that increase the value of CEOs’ private assets. Such projects are implemented sooner, receive more capital, and are less likely to be dropped. This investment strategy delivers large personal gains to the CEO but selects lower NPV projects for the firm and erodes its investment efficiency. CEO self-dealing is driven by public firms and disappears at smaller private firms where the agent is the principal. Departures of self-dealing CEOs increase firm value by 5–7%. Overall, we uncover CEOs’ private gains in capital budgeting.
2- Discount Rate Uncertainty and Capital Investment (December 2021), with Hendrik Bessembinder
[SSRN Version]
Firms obtain noisy estimates of investors’ required rates of return (discount rates) using market-based information. Discounted-cash-flow (DCF) methods as commonly taught in MBA courses lead to upward-biased estimates of project values in the presence of such noise, even when cash flow and discount rate estimates are unbiased, due to Jensen’s inequality. We show that this bias affects corporate investment decisions and firm financial performance, and we test additional predictions derived from the DCF model in the presence of noisy discount rates. Our evidence implies that a one standard-deviation increase in discount rate uncertainty is associated with increased firm investment of 6.8%, while profitability decreases by 4.1%.
Articles Published in Refereed Journals
1- Real Option Exercise: Empirical Evidence (August 2020), with Erik P. Gilje and Jérôme P. Taillard (Review of Financial Studies )
[SSRN Version] [RFS Version]
- Best paper at the 15th Annual Conference in Financial Economics at IDC-Herzliya (2018)
- Best paper at the 6th Annual USC Marshall Ph.D. Conference in Finance (2018)
We study when and why firms exercise real options. Using detailed project-level investment data, we find that the likelihood that a firm exercises a real option is strongly related to peer exercise behavior. Peer exercise decisions are as important in explaining exercise behavior as variables commonly associated with standard real option theories, such as volatility. We identify peer effects using localized exogenous variation in peer project exercise decisions and find evidence consistent with information externalities being important for exercise behavior.