Working Paper: NBER ID: w13640
Authors: Murillo Campello; John Graham
Abstract: Do firms issue stock when prices seem irrationally high? Do they invest or save the proceeds from the sale of overvalued stocks? Is value created or destroyed in the process? This paper uses a novel identification strategy to tackle these questions. We examine the capital investment, stock issuance, and cash savings behavior of financially constrained and unconstrained non-tech manufacturers ("old economy firms") around the 1990's technology bubble. Our results suggest that, because they relax financing constraints, high stock prices affect corporate policies. In particular, during the bubble, constrained non-tech firms issued equity in response to mispricing and used the proceeds to invest. They also saved part of those funds in their cash accounts. We do not find similar patterns for unconstrained non-tech firms, neither for tech firms. Our findings do not support the notion that managers systematically issue overvalued stocks and invest in ways that transfer wealth from new to old shareholders, destroying economic value. Rather, our evidence implies that what appears to be overvaluation in one sector of the economy may have welfare-increasing effects across other sectors.
Keywords: stock prices; corporate decisions; technology bubble; investment; financing constraints
JEL Codes: G31
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| High stock prices during the technology bubble (G19) | financially constrained non-tech firms issue equity (G32) |
| High stock prices during the technology bubble (G19) | financially constrained non-tech firms invest proceeds (G31) |
| High stock prices during the technology bubble (G19) | financially constrained firms save in cash accounts (G32) |
| High stock prices during the technology bubble (G19) | investment by constrained firms (G31) |
| High stock prices during the technology bubble (G19) | welfare-increasing effects across other sectors (D69) |
| Stock prices (G19) | corporate behavior (M14) |