The Stock Market and Corporate Investment: A Test of Catering Theory
The Stock Market and Corporate
Investment: A Test of Catering Theory
Christopher Polk
London School of Economics
Paola Sapienza
Northwestern University, CEPR, and NBER
We test a catering theory describing how stock market mispricing might influence individual firms’ investment decisions. We use discretionary accruals as our proxy for mispricing.
We find a positive relation between abnormal investment and discretionary accruals; that abnormal investment is more sensitive to discretionary accruals for firms with higher R&D intensity (opaque firms) or share turnover (firms with shorter shareholder horizons); that firms with high abnormal investment subsequently have low stock returns; and that the larger the relative price premium, the stronger the abnormal return predictability. We show that patterns in abnormal returns are stronger for firms with higher R&D intensity or share turnover. (JEL G14, G31)
In this paper, we study whether mispricing in the stock market has consequences for firm investment policy. We test a “catering” channel, through which deviations from fundamentals may affect investment decisions directly.
If the market misprices firms according to their level of investment, managers may try to boost short-run share prices by catering to current sentiment. Firms with ample cash or debt capacity may have an incentive to waste resources in negative NPV projects when their stock price is overpriced and to forgo positive investment opportunities when their stock price is undervalued. Managers with shorter shareholder horizons, and those whose assets are more difficult to value, should cater more.
This paper previously circulated with the title “The Real Effects of Investor Sentiment.” We thank an anonymous referee, Andy Abel, Malcolm Baker, David Brown, David Chapman, Randy Cohen, Kent Daniel, Arvind Krishnamurthy, Terrance Odean, Owen Lamont, Patricia Ledesma, Vojislav Maksimovic, Bob McDonald, Mitchell
Petersen, Fabio Schiantarelli,
Investment: A Test of Catering Theory
Christopher Polk
London School of Economics
Paola Sapienza
Northwestern University, CEPR, and NBER
We test a catering theory describing how stock market mispricing might influence individual firms’ investment decisions. We use discretionary accruals as our proxy for mispricing.
We find a positive relation between abnormal investment and discretionary accruals; that abnormal investment is more sensitive to discretionary accruals for firms with higher R&D intensity (opaque firms) or share turnover (firms with shorter shareholder horizons); that firms with high abnormal investment subsequently have low stock returns; and that the larger the relative price premium, the stronger the abnormal return predictability. We show that patterns in abnormal returns are stronger for firms with higher R&D intensity or share turnover. (JEL G14, G31)
In this paper, we study whether mispricing in the stock market has consequences for firm investment policy. We test a “catering” channel, through which deviations from fundamentals may affect investment decisions directly.
If the market misprices firms according to their level of investment, managers may try to boost short-run share prices by catering to current sentiment. Firms with ample cash or debt capacity may have an incentive to waste resources in negative NPV projects when their stock price is overpriced and to forgo positive investment opportunities when their stock price is undervalued. Managers with shorter shareholder horizons, and those whose assets are more difficult to value, should cater more.
This paper previously circulated with the title “The Real Effects of Investor Sentiment.” We thank an anonymous referee, Andy Abel, Malcolm Baker, David Brown, David Chapman, Randy Cohen, Kent Daniel, Arvind Krishnamurthy, Terrance Odean, Owen Lamont, Patricia Ledesma, Vojislav Maksimovic, Bob McDonald, Mitchell
Petersen, Fabio Schiantarelli,
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