Working Papers
8- Valuation Fundamentals (May 2024), with John Graham
[Draft coming soon]
We study subjective valuation using a comprehensive sample of analyst reports that contain detailed information on short-term, medium-term, and terminal growth expectations, as well as subjective discount rates. Both growth expectations and subjective discount rates play a crucial role in explaining valuation fluctuations. Subjective discount rates are guided by theoretical recommendations (CAPM), track managers' estimates, reflect inflation, and vary over time with the risk-free rate and subjective betas being the main drivers of time-series fluctuations. Discount rates are unbiased predictors of future returns, return predictability is mainly associated with innovations in firm subjective betas, and the analyst's security market line is steeper than the econometrician's. To rationalize these patterns, we investigate how analysts update discount rate inputs. Drawing from textual descriptions and using a noisy information model, we find that analysts are forward-looking and attempt to filter estimation noise when adjusting inputs. These subjective adjustments appear to mitigate the effect of noise in model estimates, and lead to stickier processes than simply using benchmark model outputs. Finally, terminal growth rates track real GDP growth, but not inflation.
7- What Drives Very Long-Run Cash Flow Expectations? (May 2024), with Marius Guenzel
- Best paper at the 2024 VSB Mid-Atlantic Research Conference
[SSRN Version]
We study the very long-run expectations of professional forecasters using a large novel dataset that combines forecasters' beliefs about firms' terminal growth rate (TGR), qualitative text discussions of their beliefs, and detailed forecaster demographic information. We establish four findings about forecasters' TGR beliefs—their expectations about firms' long-run growth rate ``until infinity.'' First, TGR expectations contain distinct economic information compared to shorter forecasting series and robustly predict realized long-run firm growth. Second, consistent with firm life-cycle models, a rich set of factors explains TGR beliefs for young firms, while country and industry factors account for most of the variation for mature firms. Third, there exists large, persistent heterogeneity in TGR expectations across forecasters, with forecaster demographics explaining a sizable share of this heterogeneity. Lastly, we use forecasters' textual discussions to estimate a topic model and open the black box behind quantitative expectations. Divergent long-term growth expectations stem primarily from subjective interpretations of similar topics, rather than from coverage of different topics.
6- Resolving Estimation Ambiguity (May 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 ambiguity 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.
5- 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.
4- Strategic Learning and Corporate Investment (August 2022), with Michael Wittry - Revise & Resubmit 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.
3- Capital Budgeting and Idiosyncratic Risk (May 2024) - Revise & Resubmit at The Journal of Financial Economics
[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.
2- Self-Dealing in Corporate Investment (May 2024), 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 a NPV-based revealed-preference strategy, I find that managers increase the discount rate used in capital budgeting decisions upward to account for idiosyncratic risk. To establish causality, I exploit quasi-exogenous within-region variation in project-specific idiosyncratic risk. I then decompose the measure of idiosyncratic risk into a good and a bad component and show that discount rate adjustments appear to penalize exposure to downside risk. Finally, I explore how costly external financing, internal monitoring frictions, and CEOs' personal exposure to idiosyncratic risk affect those adjustments. Overall, financial and operational frictions induce managers to account for idiosyncratic risk when computing discount rates.
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.
Resting Papers
Discount Rate Uncertainty and Capital Investment (December 2021), with Hendrik Bessembinder