Researcher Profile: Vefa Tarhan, Finance Professor
A paper co-authored by Quinlan finance professor Vefa Tarhan was recently published in the Journal of Financial Economics, which is one of the top three finance journals in the world.
High-quality research makes faculty better educators, says the native of Turkey, as it helps faculty teach the subtleties of complex financial issues. Tarhan adds that research also contributes to the reputation of Quinlan.
Tarhan has a wide range of research interests, including financing decisions, monetary policy, capital market constraints, mergers and acquisitions, share repurchases, and bank portfolio management.
Here, he discusses his Journal of Financial Economics paper and explains why research is important for the academic and business worlds.
What questions are you trying to answer in your paper?
The most important decision businesses have to make is about which investments to make and which ones to avoid. Firms make these decisions by comparing the cost of the investment to the future benefits it may provide. To calculate this, firms often use discount rates based on the cost of the financial and operational capital needed for an investment.
When compared to financial theory, the firms in our sample were using discount rates that were on average substantially higher than they should be and were potentially passing on projects that they should undertake. We wanted to find out what causes this.
Similar research papers state that firms can’t find enough money for their investments, but our research proved that this isn’t true. The constraint in our sample is that companies don’t have enough good managers. Management talent is a scarce resource, apparently, because firms have expressed a lack of quality human capital to oversee as many good investment projects as they could have undertaken.
Our conclusion is that successful firms are the ones that invest in great products and ideas and have the ability to say no to mediocre investment opportunities. These firms use high discount rates to forego some good projects and pursue even better opportunities.
What drew you to this research area?
When you’re a finance student, you’re taught the theoretical issues and concepts. However, students frequently complain about a disconnect with the real-world application of these theories. This, primarily, motivates me to see to what extent the content we’re teaching at Quinlan is true in the real world. I want to see whether the world works in the manner textbooks claim it works.
More specifically, there are numerous research papers that are trying to find the answers to the same question about discount rates. Yet, there wasn’t a true explanation for it; it was a mystery.
Why is this topic of interest to businesses?
In theory, businesses should undertake all investment projects when the benefits exceed costs. But, when it comes to investments, no one can predict the future. So it’s especially important for firms to make investment decisions with discount rates to bring these future benefits to the present, in order to compare it with the money they have to spend today. Especially since firms have operational constraints due to a lack of good management to oversee investments, evaluating and choosing only the best investment project will help businesses move forward.
What makes your research relevant to Quinlan students?
In my case, I like to teach application-oriented courses. Since I’ve done the research, I’m able to go beyond teaching at the textbook level; beyond the obvious. Quinlan students are heavily interested in applying what’s learned in the classroom to current events in the world.
For example, in my research, theory states that companies should act on all investments that provide benefits that exceed all costs of capital, but this simply isn’t true in the real world. What we’ve found doesn’t mean that textbooks are wrong; it’s just that they don’t talk about management talent. The types of research that interest me are those that explores issues beyond textbook version of how things work.
Why do you submit your research to top journals?
I go for quality by trying to write papers that would make significant contributions to our understanding of financial issues.
My goal has never been – even when I was a young faculty without tenure – to maximize the number of research papers. My goal has always been to try to work on research projects that may make significant contributions to the finance field. In other words, when it comes to research, I have been willing to sacrifice quantity, in hopes that perhaps I may be able to produce high-quality articles.
How else do you partner with the business community and policy-makers?
I’ve always wanted to get my hands dirty and do something of significance.
In my younger days, I began by consulting for firms. But now I try to give back some of my human capital to the country I was born in by consulting with political parties in Turkey on economic and financial issues. I also have good relations with the business community. Now, I get together with CEOs of major corporations 2 to 3 times a year in Turkey.