The Stock Market and Corporate Investment: A Test of Catering Theory
Year: 2008
Type: article
Abstract: We test a catering theory describing how stockmarketmispricingmight 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 con-sequences 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
Source: Review of Financial Studies
DOI: 10.1093/rfs/hhn030
Authors: Christopher Polk, Paola Sapienza
Language: English
Subfield: Finance
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2032947759