RFS Advance Access published online on April 2, 2008
Review of Financial Studies, doi:10.1093/rfs/hhn030
The Stock Market and Corporate Investment: A Test of Catering Theory
London School of Economics
Northwestern University, CEPR, and NBER
Address correspondence to Paola Sapienza, Finance Department, Kellogg School of Management, Northwestern University, 2001 Sheridan Rd., Evanston IL 60208; telephone: 1-847-491-7436; fax: 1-847-491-5719; e-mail: Paola-Sapienza{at}northwestern.edu.
JEL Classification: G14, G31
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Abstract |
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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 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.
This paper previously circulated with the title "The Real Effects of Investor Sentiment." We thank an anonymous referee, Andy Abel, Malcolm Baker, David Brown, David Chapman, Randy Cohen, Kent Daniel, Arvind Krishnamurthy, Terrance Odean, Owen Lamont, Patricia Ledesma, Vojislav Maksimovic, Bob McDonald, Mitchell Petersen, Fabio Schiantarelli, Andrei Shleifer, Jeremy Stein, Tuomo Vuolteenaho, Ivo Welch, Luigi Zingales, and seminar participants at Harvard Business School, Helsinki School of Economics, London Business School, McGill University, University of Chicago, University of Virginia, the AFA 2003 meeting, the NBER Behavioral Finance Program meeting, the Texas Finance Festival, the University of Illinois Bear Markets conference, the Yale School of Management, the WFA 2002 meeting, and the Zell Center Conference on "Risk Perceptions and Capital Markets." We thank Sandra Sizer for editorial assistance. We acknowledge support from the Investment Analysts Society of Chicago Michael J. Borrelli CFA Research Grant Award. Polk acknowledges the support of the Searle Fund. The usual caveat applies.