Working Paper: NBER ID: w13762
Authors: Malcolm Baker; Robin Greenwood; Jeffrey Wurgler
Abstract: We propose and test a catering theory of nominal stock prices. The theory predicts that when investors place higher valuations on low-price firms, managers will maintain share prices at lower levels, and vice-versa. Using measures of time-varying catering incentives based on valuation ratios, split announcement effects, and future returns, we find empirical support for the predictions in both time-series and firm-level data. Given the strong cross-sectional relationship between capitalization and nominal share price, an interpretation of the results is that managers may be trying to categorize their firms as small firms when investors favor small firms.
Keywords: Catering theory; Nominal share prices; Stock splits; Investor sentiment
JEL Codes: G12; G3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Catering incentives (M52) | Nominal share prices (G19) |
| Investor preferences (G11) | Managerial decisions regarding share prices (G11) |
| Catering incentives (M52) | Frequency of stock splits (G35) |
| Higher valuations of low-priced firms (G19) | Lower average postsplit prices (P22) |
| Frequency of splits (C41) | Lower future returns for small and low-priced stocks (G17) |