Value Relevance of Capital Expenditures and the Business Cycle

Abstract

We examine the relationship between corporate capital investments and the business cycles. Specifically, we test whether the stock market exhibits different reactions to corporate capital expenditures under various business conditions, and provide evidence that US firms’ capital expenditures during an expansionary business cycle are more value relevant to capital market participants and conversely, less value relevant for contractionary cycles, which corroborate and validate previous literature that has found uncertain, cyclical nature of information contents of capital expenditures. Our finding has various implications for capital market participants; investor for gauging the expected future cash flows for the firm from the capital expenditures, creditors for extending credits to firms as they have more accurate information on the viability of long term investment, and for managers for planning long term capital expenditures across the different business cycles. The capital expenditures are good news for investors, but investors will make a better returns when firms make a capital expenditures during the expansionary period. Our results also suggest to creditors that an excessive amount of loans during the contractionary period may be suboptimal as the debtors’ returns on capital investment are less than those of the expansionary period. Ceteris paribus, capital investments during the expansionary period is more value relevant than those of contractionary period.