Does feedback effect exist in firms' investment decisions? From the perspective of equity liquidity

Abstract

We explore the relationship between information asymmetries and firms' investment decisions. We find that severe information asymmetries can decrease firms' investment efficiency, especially increasing their over‐investments. In turn, firms' adjustments of their investment decisions towards the target can alleviate information asymmetry. Our results are not only in accordance with the signaling hypothesis, which states that firms' financial decisions carry information that is useful to the public, but also consistent with the feedback hypothesis, which states that outsiders can generate information that guides managers' decisions by trading stocks. Our findings have implications regarding both managers' incentives to be involved in inefficient investments and outsiders' ability to process information.