Changes In Investment Opportunities Research Articles

The costs of corporate debt overhang

We make use of rich U.S. data to show that debt overhang significantly reduces firm asset-, capex-, and employee-growth. We show these contractions are likely driven by firm decisions as opposed to the result of credit constraints or changes in investment opportunities. Our measure of overhang – liabilities to cash flow — aligns with traditional theory and focuses on the importance of a firm’s debt servicing capacity. It further allows us to capitalize on the COVID-19 shock as a quasi-natural experiment to confirm the impact of overhang on firm investment and growth.

Risk Characterization of Firms with ESG Attributes Using a Supervised Machine Learning Method

We examine the risk–return tradeoff of a portfolio of firms that have tangible environmental, social, and governance (ESG) attributes. We introduce a new type of penalized regression using the Mahalanobis distance-based method and show its usefulness using our sample of ESG firms. Our results show that ESG companies are exposed to financial state variables that capture the changes in investment opportunities. However, we find that there is no economically significant difference between the risk-adjusted returns of various ESG-rating-based portfolios and that the risk associated with a poor ESG rating portfolio is not significantly different than that of a good ESG rating portfolio. Although investors require return compensation for holding ESG stocks, the fact that the risk of a poor ESG rating portfolio is comparable to that of a good ESG rating portfolio suggests risk dimensions that go beyond ESG attributes. We further show that the new covariance-adjusted penalized regression improves the out-of-sample cross-sectional predictions of the ESG portfolio’s expected returns. Overall, our approach is pragmatic and based on the ease of an empirical appeal.

Does stock market listing boost or impede corporate investment?

This paper investigates investment behavior across public and privately held firms using a novel firm-level dataset. We use coarsened exact matching to construct a control group of firms with which we compare listed firms before and after listing in a difference-in-differences framework. The results reveal that stock market listing spurs growth significantly in terms of sales, employment and assets for manufacturing firms. Furthermore, they indicate that listed manufacturing firms invest more than their non-listed counterparts. In addition, their investment decisions are significantly more sensitive to changes in investment opportunities, and they respond more aggressively. These results constitute evidence rejecting the existence of short-termism for listed manufacturing firms in Turkey, and also highlight the importance of financial development in increasing employment, firm growth and allocating capital efficiently.

Do the Q-Factors Proxy for Surprises in Economic State Variables?

In this paper, we investigate whether q-factors, ME, I/A, and ROE correlates the surprises in economic state variables that describe the changes in investment opportunities within the Intertemporal CAPM framework. The paper shows that ME, I/A, and ROE significantly correlate with the surprises in economic state variables. In particular, we find that ME correlates with the surprises in default spread, term spread, and treasury-bill yield; while I/A is related to the surprises in aggregate dividend yield. The profitability factor ROE correlates with surprises in term spread and default spread. These findings suggest that the q-factors are related to the surprises in economic state variables. We also show that for each portfolio formation, loadings on surprises in economic state variables resemble the loadings or a mirror image of loading on q-factors. These findings suggest that the q-factors may act as a proxy for the surprises in economic state variables that describe the changes in the investment opportunity set. The paper adds more insights to the ongoing debate on the theoretical justification of q-factors ME, I/A, and ROE.

Does going public imply short-termism in investment behavior? Evidence from China

Adopting a large panel of Chinese manufacturing firms together with the data of listed firms for the period 1998–2007, this paper aims to examine whether Asker et al.'s (2015) argument on the short-termism demonstrated in the investment behavior of listed firms holds for China. We document that listed firms engage in more investments and respond more to changes in investment opportunities as compared to unlisted ones with similar size and age in the same industries, and Asker et al.'s (2015) short-termism argument only holds for firms facing sufficiently low financing constraints.

Capital allocation and ownership concentration in the shipping industry

We measure the sensitivity of investment to changes in investment opportunities in the shipping industry, and test whether this relation is moderated by ownership concentration. For a sample of 126 globally listed shipping firms, we find that investment in commercial shipping follows freight rates, a measure of the potential income stream from owning a vessel. Ownership concentration, measured as the ownership stake of the largest shareholder, reinforces the positive effect of freight rates on investment, indicating a higher relative efficiency of capital allocation. The positive impact ownership has on the investment-freight rate sensitivity also translates into higher firm value. An analysis of investor identity shows that our results are driven by the group of firms where the largest owner is a financial investor, who is usually more focused on shareholder value maximization.

Investment Slumps During Financial Crises: The Role of Credit Constraints

To measure the real effects of credit-supply disruptions during financial crises, we develop a quantitative model of firm investment and debt that features firm heterogeneity and financial frictions. We apply this framework to a novel, census-type panel dataset for manufacturing firms and find that the contraction in credit supply during the Greek Depression was responsible for 9-36% of the drop in corporate investment after controlling for changes in investment opportunities and uncertainty. Our empirical framework does not require cross-sectional variation in credit-supply conditions to separate the demand for credit from its supply. This feature is particularly useful for studying financial crises when credit-supply shocks are likely to have a substantial common component. Our model also helps to explore the effectiveness of counterfactual policies of fiscal stimulus or debt forgiveness for boosting corporate investment.

Ownership Concentration, Investment, and Firm Value in the Shipping Industry

We measure the sensitivity of investment to changes in investment opportunities in the shipping industry and test whether this relation is moderated by ownership concentration. For a sample of 126 globally listed shipping firms, we find that investment in commercial shipping follows freight rates, a measure of the potential income stream from owning a vessel. Ownership concentration, measured as the ownership stake of the largest shareholder, reinforces the positive effect of freight rates on investment, indicating a higher relative efficiency of capital allocation. The positive impact ownership has on the investment-freight rate sensitivity also translates into higher firm value. An analysis of investor identity shows that our results are driven by the group of firms where the largest owner is a financial investor, who is usually more focused on shareholder value maximization.

Financing and New Product Decisions of Private and Publicly Traded Firms

We exploit Medicare national coverage reimbursement approvals as a quasi-natural experiment to investigate how the financing decisions of private and publicly traded firms respond to changes in investment opportunities. We find that publicly traded companies increase their external financing and their subsequent product introductions by more than private companies in response to national coverage approvals. Private equity financing is the primary source of the increased financing for public firms. We show that the stock characteristics of publicly traded firms, such as liquidity and price informativeness, and product market competition are important factors in explaining their financing advantage.

Intangible capital and the investment-q relation

The neoclassical theory of investment has mainly been tested with physical investment, but we show that it also helps explain intangible investment. At the firm level, Tobin’s q explains physical and intangible investment roughly equally well, and it explains total investment even better. Compared with physical capital, intangible capital adjusts more slowly to changes in investment opportunities. The classic q theory performs better in firms and years with more intangible capital: Total and even physical investment are better explained by Tobin’s q and are less sensitive to cash flow. At the macro level, Tobin’s q explains intangible investment many times better than physical investment. We propose a simple, new Tobin’s q proxy that accounts for intangible capital, and we show that it is a superior proxy for both physical and intangible investment opportunities.

Do Private Firms Invest Differently than Public Firms? Taking Cues from the Natural Gas Industry

ABSTRACTWe study how listing status affects investment behavior. Theory offers competing hypotheses on how listing‐related frictions affect investment decisions. We use detailed data on 74,670 individual projects in the U.S. natural gas industry to show that private firms respond less than public firms to changes in investment opportunities. Private firms adjust drilling activity for low capital‐intensity investments. However, they do not increase drilling in response to new capital‐intensive growth opportunities. Instead, they sell these projects to public firms. Our evidence suggests that differences in access to external capital are important in explaining the investment behavior of public and private firms.

Nepotism Everywhere: The Real Effects of Widespread Family Ties

This paper provides evidence for a causal effect of nepotism on corporate investment. To measure nepotism, we build a unique database that tracks potential conflicts of interest arising from family connections among directors, shareholders and other stakeholders. Our analysis indicates that firms in which family ties are widespread invest substantially less than peer firms and are less responsive to changes in investment opportunities. To establish causality, we use state-level divorce and marriage rates as sources of exogenous variation in the most popular form of family tie in our sample, a director's link to his wife. The effect that we uncover is robust to the exclusion of family firms. Overall, our results suggest that underinvestment in nepotistic firms is driven by the diversion of resources out of the firm via generous payouts and higher salaries.

Is the Public Sector Generating Sufficient Revenue from Its Resources? The Investment Behavior of Public and Private Firms

Public and private firms invest differently. Stock markets provide investors with liquidity and opportunities for diversification and reduce firms’ cost of capital. The authors evaluate the differences in investment behavior between market-listed and privately held firms in India using a new data source on private firms. They observe that listed firms invest less and are less responsive to changes in investment opportunities than private firms. These differences are not because of unobserved differences between public and private firms, how they measure investment opportunities, or lifecycle differences. The patterns are consistent with theoretical models emphasizing the role of managerial myopia.

Financing Decisions and Product Introductions of Private and Publicly Traded Firms

We exploit Medicare national coverage reimbursement approvals of medical devices as a quasinatural experiment to investigate how private and publicly traded firm financing decisions and product introductions respond to exogenous changes in investment opportunities. We find that publicly traded companies increase their external financing, and their subsequent product

Corporate Investment and Stock Market Listing: A Puzzle?

We investigate whether short-termism distorts the investment decisions of stock market-listed firms. To do so, we compare the investment behavior of observably similar public and private firms, using a new data source on private U.S. firms and assuming for identification that closely held private firms are subject to fewer short-termist pressures. Our results show that compared with private firms, public firms invest substantially less and are less responsive to changes in investment opportunities, especially in industries in which stock prices are most sensitive to earnings news. These findings are consistent with the notion that short-termist pressures distort investment decisions.

Intangible Capital and the Investment-q Relation

The neoclassical theory of investment has mainly been tested with physical investment, but we show it also helps explain intangible investment. At the firm level, Tobin's q explains physical and intangible investment roughly equally well, and it explains total investment even better. Compared to physical capital, intangible capital adjusts more slowly to changes in investment opportunities. The classic q theory performs better in firms and years with more intangible capital: Total and even physical investment are better explained by Tobin's q and are less sensitive to cash flow. At the macro level, Tobin's q explains intangible investment many times better than physical investment. We propose a simple, new Tobin's q proxy that accounts for intangible capital, and we show that it is a superior proxy for both physical and intangible investment opportunities.

Investment sensitivity and managerial decision making behaviour of Indian firms

Contemporary models of the financial theory support the proposition that the stock prices should be fundamentally a reflection of the discounted value of earnings. Accordingly the investors and analysts should base their expectations on the expected future cash flows that are logically correlated or have a carry over effect vis-ŕ-vis present stream of cash flows. This logically implies that the managers would have an incentive to manipulate investor’s expectation of future cash flows. The zeal to maximize the firm’s value based on market capitalization is expected to have a detrimental effect on the investment decisions leading to sub optimality. Given the imperfect information structure and market pressures, the Indian firms suffer from mispricing and as such the conventional robust theoretical models of agency conflicts cannot be refuted. This motivates us to examine the interrelation ship between the concerns for valuation and investment sensitivity. We use a sample statistics of selected listed firms that represent the CNX Nifty Index and test for the dependence of the investment behavior of the firm, on the sensitivity of the firms’ share prices to its current cash flow represented by surprise earings. We use the earnings response coefficient (ERC) framework proposed by Ball and Brown (1968) for 11 key industries in India. We find that the surpise in accounting earnings announcements is negatively associated with abnormal stock returns and the investment decisions taken by the firms are negatively sensitive to changes in investment opportunities.

Differential Ability to Recognize Emerging Developments and Corporate Performance Under Uncertainty

Research in psychology and biology shows that individuals differ in their ability to recognize changes in the environment and that these differences arise as an adaptive response to uncertainty. We argue that the said ability is relevant to decision making under uncertainty. We conduct empirical tests in which we infer the ability to recognize emerging developments from the propensity to take costly precautionary actions in the face of uncertainty (we dub it prudence). Using a large sample of U.S.-listed firms over a thirty-year period, we report that (i ) prudent firms exhibit greater long-term profitability than firms that have never taken precautionary actions, (ii ) the positive association between prudence and profitability monotonically increases in uncertainty, (iii ) prudence does not convey any benefits in low-uncertainty environments, and (iv) prudent firms are more responsive to changes in investment opportunities. The results are consistent with the theoretical predictions.

Valuing Changes in Investment Opportunities

Arrow and Pratt introduced a measure of risk aversion—the negative ratio of the second to the first derivative of the utility function. This measure has found widespread use in the valuation of uncertain lotteries and in the calculation of the risk premium of an investment. This paper introduces two new measures for characterizing changes in the valuation of uncertain lotteries when their outcomes are modified by a monotone transformation. The first is a characteristic transformation of a utility function, U, and a monotone transformation, g. The shape of the characteristic transformation determines an upper bound, lower bound, or equality on the magnitude of the certainty equivalent of the modified lottery. The second is a measure of change in certainty equivalent, ηg, whose sign also determines upper or lower bounds, and whose magnitude determines the change in value of a “small-risk” lottery when its outcomes are modified by a monotone transformation. For shift (and scale) transformations on the lottery outcomes, both the characteristic transformation and the measure of change, ηg, provide new characterizations for the notions of decreasing absolute (and relative) risk aversion with wealth.

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