Professor Kilian Huber

Biography

Kilian Huber is Professor of Economics and Finance at The University of Chicago Booth School of Business. Before joining the faculty at Chicago Booth, he was the inaugural Saieh Family Fellow in Macroeconomics at the Chicago Becker Friedman Institute and received a PhD from the London School of Economics (LSE). His recent awards include a Sloan Fellowship and a Lamfalussy Fellowship. Huber’s research studies how firms make investment decisions, often by focusing on the interaction between the financial sector and the real economy as well as the propagation of shocks across different parts of the economy. His academic papers have analysed how banks affect firm growth, how firms react to interest rate and asset price fluctuations, how connections between different industries and regions shape macroeconomic growth, and how discriminatory ideologies harm firms.

How does it feel to be shortlisted for the Panmure House Prize? 

The themes emphasized by Panmure House have always been close to my heart. Are economic systems around the world incentivizing long-term investment and innovation? How do firms and households make long-term decisions? What is the role of free markets and governments? It has been inspiring to see Panmure House supporting new work on these themes.

In my research, I tackle related questions. I am very grateful to Panmure House for considering my work. It is a great honor to be listed among such wonderful researchers, including past prize winners who have done seminal work and this year’s group of talented scholars.

How did you find out about the Panmure House Prize and what was it that attracted you to apply?

Adam Smith’s work is an inspiration for every social scientist. I have followed the activities of Panmure House for several years, in particular, the application of Smith’s insights to modern social questions. The priorities of Panmure House overlap with my research interests in several dimensions.

Could you give us a brief introduction to your research for people who might not be from an academic background, could you explain what is the problem you are trying to solve?

My research investigates how firms determine their long-run investment, innovation, and productivity.

The standard advice on how firms should select the right investment projects goes back to Adam Smith. A key principle is that firms should invest until the financial return to a potential project equals the return to other projects with comparable risk and time horizon. If firms behave this way, we generally think that the right projects get selected in market economies, the most promising ideas get developed, and the economy becomes more productive.

Much of my research studies the extent to which modern firms adhere to Smith’s principle and why this matters. My coauthors and I spent several years collecting new data on the minimum returns that different firms want to earn when evaluating new investment projects. These minimum returns are captured by values used internally in firms, called “discount rates.” We manually read through hundreds of thousands of firm statements and systematically recorded the relevant values, resulting in a firm-level database covering 20 countries costofcapital.org

Using the new data, we document that when firms decrease their discount rates, they raise investment, for example, in machines, equipment, and innovation. Discount rates therefore play a key role in firm decisions, in line with Smith’s view. However, the discount rates of most firms are not equal to the returns of other comparable projects, deviating from Smith’s principle. Discount rates are often higher than the returns of comparable projects, implying that firms, on average, invest and innovate too little. An equivalent interpretation is that firms’ thinking does not put sufficient weight on long-term outcomes. This short-termism comes at the expense of long-run productivity and growth.

Moreover, firms have been unwilling to reduce their discount rates in recent decades, even though financial markets and interest rates have become more favorable. This behavior can partly account for the lack of investment and dynamism seen in advanced economies since 2000 (sometimes known as the “missing investment” puzzle).

At the same time, the findings are encouraging in some dimensions. For instance, the behavior of firms’ discount rates implies that a market-based mechanism can incentivize long-run climate-friendly investments by firms, by signaling through the “invisible hand” of the market how firms should evaluate green projects. In related work, I have also explored the key role played by banks for the innovation and productivity of firms.

How do you conduct your research?

My research aims to establish facts using new data, often extracted from historical sources or textual firm statements. I use the empirical findings to shed light on conventional assumptions made by researchers and policymakers. If necessary, I hope to enhance the conventional view and draw empirically grounded lessons for practitioners and policymakers. The ambition is to study aspects of firm behavior that matter both to individual firms and to the economy as a whole.

My approach to research draws inspiration from several fields. My passion for collecting new data from primary sources is inspired by history. For instance, my coauthors and I spent years manually reading transcripts of manager statements to measure discount rates and combing through archives to measure bank-firm relationships.

To guide the data analysis, I learn from stylized theories developed in economics and finance. For instance, standard models suggest that firms can optimally choose investment and innovation projects by considering the returns of comparable projects in financial markets. In addition to stylized theory, I try to learn from practically oriented fields, such as management and finance, which suggest that simple models may not fully capture the complex challenges facing firms, for example, the management of multiple divisions. 

How do you envision your work will advance long-term thinking and innovation in your field and beyond?

Discount rates are practical objects used by firms to guide long-term plans. Since discount rates were traditionally unobserved, policymakers and researchers have relied on strong assumptions on how discount rates behave. Based on our results, the conventional wisdom about the determinants of long-run investment, innovation, and productivity should be reconsidered. We offer new ideas for government policies that may encourage long-term thinking and investment.

In general, policies that shift firms’ discount rates directly tackle a key determinant of long-run thinking in firms. Such policies can thus have direct effects on investment and innovation. For instance, policies that target the funding costs of climate-friendly investments directly shift firms’ discount rates, which can help to mitigate climate change. Moreover, policies stimulating private consumption or inflation expectations have direct effects on long-run investment decisions, making them more powerful than previously thought. In comparison, standard monetary policy that targets short-run interest rates is less powerful in stimulating real investment and innovation than in standard models.

The findings also offer lessons for firms. We show that firms find it difficult to set discount rates optimally, because it requires complex evaluations based on financial market prices. Deviations from the best possible choice can have negative real consequences on the development of new ideas, investment, and resource allocation. Our current and ongoing work studies how firms can improve their discount rate setting and thus their long-term thinking.

What are you working on next?

In ongoing research, we study how firms should set their discount rates. It is challenging for firms to identify the right discount rate because the returns of comparable projects are not easily observed. The typical advice is to extract information from financial markets, but there is little practical guidance on how to implement this advice.

The choice of discount rate is key. It determines the long-run investment, innovation, and types of projects chosen by firms. For instance, firms are more likely to forgo projects with long-run payoffs, such as investments in green production, if firms continue to apply high, inflexible discount rates.

In ongoing work, we provide easy-to-use and unbiased methods to calculate discount rates. The resulting dataset will allow firms to identify a tailor-made discount rate for their specific situation.