Working Papers
Capital Budgeting and Idiosyncratic Risk
[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
This figure contrasts the projects' production forecast rate of decline with the realized production rate of decline of the median gas well, and the 10th and 90th percentile.
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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 by 5 percentage points (pp) in response to an 18pp increase in idiosyncratic risk. Moreover, these discount rate adjustments are negatively associated with measures of firm profitability. I then explore how proxies for costly external financing and agency frictions relate to discount rate adjustments. Consistent with theoretical predictions, firms appear to adjust their discount rate to account for both frictions.
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Discount Rate Uncertainty and Capital Investment (December 2020), with Hendrik Bessembinder
[SSRN Version]
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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%.
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CEO Pet Projects (December 2020), with Denis Sosyura
[SSRN Version]
This figure represents a property included in our sample and the associated drilling activity in its vicinity. The yellow region indicates the location of the property as indicated on google map. The property in the figure spans roughly 95.65 acres (i.e., 0.4 km squared). Each red dot on the figure represents a distinct oil and gas well drilled during the sample period 2000 and 2020.
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Using hand-collected data on CEOs’ personal assets, we find that CEOs prioritize corporate investment projects that increase their private assets’ value. Such pet 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. Using information from CEOs’ relatives as an instrument for the location of their private assets, we argue that these effects are causal. Overall, we uncover the impact of CEOs’ private monetary interests in capital budgeting decisions.
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Articles Published in Refereed Journals
Real Option Exercise: Empirical Evidence, 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)
This figure plots the distribution of the estimated forgone value, the difference between the underlying value (V) and the real option trigger value (V*) (i.e., V-V*) . A value to the left of the vertical line at zero corresponds to exercising the real option too early.
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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.
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