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Journal of Finance Vol. 70 No. 3 2015

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

Philipp Krüger1,2,3,4,5; Augustin Landier1,2,3,4,5; David Thesmar1,6,2

1 University of Geneva · 2 Toulouse School of Economics · 3 HEC Paris in Qatar · 4 Swiss Finance Institute · 5 HEC Paris · 6 Center for Economic and Policy Research

open access

Abstract

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.

DOI
10.1111/jofi.12250
Volume
70
Issue
3
Pages
1253-1285
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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