Working Paper: NBER ID: w10563
Authors: Christopher Polk; Paola Sapienza
Abstract: We study how stock market mispricing might influence individual firms' investment decisions. We find a positive relation between investment and a number of proxies for mispricing, controlling for investment opportunities and financial slack, suggesting that overpriced (underpriced) firms tend to overinvest (underinvest). Consistent with the predictions of our model, we find that investment is more sensitive to our mispricing proxies for firms with higher R&D intensity suggesting longer periods of information asymmetry and thus mispricing) or share turnover (suggesting that the firms' shareholders are short-term investors). We also find that firms with relatively high (low) investment subsequently have relatively low (high) stock returns, after controlling for investment opportunities and other characteristics linked to return predictability. These patterns are stronger for firms with higher R&D intensity or higher share turnover.
Keywords: Investor Sentiment; Market Mispricing; Firm Investment
JEL Codes: G31; G32; E22
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mispricing proxies (G19) | firm investment (G32) |
| overpriced firms (L11) | overinvest (G31) |
| underpriced firms (L11) | underinvest (G31) |
| R&D intensity (O32) | sensitivity to mispricing proxies (G41) |
| high share turnover (G34) | sensitivity to mispricing proxies (G41) |
| high investment (G31) | lower stock returns (G17) |
| irrational stock price fluctuations (G41) | investment decisions (G11) |