Abstract

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 RD 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.

Full Text

Submitted Version (Free)

Published Version

Talk to us

Join us for a 30 min session where you can share your feedback and ask us any queries you have

Schedule a call

Disclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.