DNRF Chair

My research is focused on how financial markets influence firms’ cost of capital and thereby firms’
investment decisions and behavior. A basic idea in corporate finance is that firms should make
investment decisions based on their cost of capital. When firms consider whether to make a new
investment, such as an investment in a new factory, they should compare the return of the
investment with the cost the firm has to pay to obtain funding for the investment. The appropriate
cost is referred to as the “cost of capital.” Business schools teach managers to use the cost of capital
as the basis of their investment decisions, and most large firms attempt to act in this way. However,
the cost of capital is not a number that is observed by firms or economists, but a number that must
be estimated based on data from financial markets. This estimation is a difficult process, so it is
likely that firms estimate their cost of capital with error. Traditionally, the field of finance has
assumed that firms estimate their cost of capital correctly and behave exactly as in the textbooks.
But my work studies how firms actually perceive their cost of capital. I find that their perceptions
deviate substantially from the assumptions of standard models.
To understand firms’ perceptions of their cost of capital, I have collected data from thousands of
firms on what they think their cost of capital is. The data were collected from manual reading of
transcripts of more than 100,000 “corporate earnings calls” (calls where a firm’s managers talk to
equity analysts), using a team of more than 30 research assistants. Based on these data, I study
how firms’ form their perceptions of their cost of capital, what kind of mistakes they make, and
how these mistakes influence the economy. Given that the cost of capital is one of the core topics
taught in business schools, the research from the cost of capital lends itself directly to teaching
materials that are already being used in the teaching at leading business schools.
The new data lend itself to study many important open research questions. One question is how
firms’ perceptions of their cost of capital help shape the corporate response to climate change.
Standard theory suggests that when large investors such as pension funds invest in green assets,
they should lower the cost of capital for green projects, making firms invest in more green projects.
There is currently a big debate in the academic literature on whether this basic mechanism works
in practice, and the data on the perceived cost of capital is uniquely situated to answer this question,
something I am currently working on. We are also studying the normative question of how firms
should calculate their cost of capital given the uncertainty inherent in financial market prices, how
firms’ perceptions of their cost of capital influences monetary policy, the historical diffusion of
cost of capital techniques in firm management, and the firm-level consequences of using incorrect
estimates of the cost of capital.
The data collection itself is also an ongoing process, that has so far required the effort of a relatively
large research group. I have been running a research group with my collaborator, Kilian Huber, at
University of Chicago, which employs around 3 full-time research assistants, 10-20 part-time
researchers, and PhD students. The plan is to shift much of the labs’ research activities to Copenhagen over the next years. The manual data collection that is already set in place in Chicago
will continue there for now, but two new data collection efforts will be started in Copenhagen.
First, we plan to incorporate AI into the data collection effort. For the previous five years, we have
collected data through manual reading of corporate statements. While human reading was a
necessity in the beginning, much of this activity can now be done by using AI. We have already
explored this methodology, and we have a plan for implementing it over the next three years in
Copenhagen. Another new project involves data collection that goes further back in time, and
which is key for our studies of the diffusion of cost of capital techniques in the management of
large corporations. This data collection will also be conducted in Copenhagen.
My other line of work is asset pricing, which involves studying the true cost of capital in financial
markets. One line of my asset pricing research – conducted together with Eben Lazarus from
Berkeley University – studies how interest rates influence stock prices. Our work shows that this
depends critically on a concept called equity duration. We have developed new methodologies for
estimating duration, and these new methods suggest that duration is a first-order characteristic for
understanding fluctuations in asset prices. This agenda is still work in progress. Our near-term goal
in this agenda is to share the methodologies and measures of duration that we are currently working
on, such that their application can be more widespread among researchers and financial
practitioners.