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Corporate Investment and Financial Markets

Paper Session

Saturday, Jan. 7, 2023 10:15 AM - 12:15 PM (CST)

Sheraton New Orleans, Rhythms III
Hosted By: American Finance Association
  • Chair: Itay Goldstein, University of Pennsylvania

Technological Progress, Managerial Learning, and the Investment-to-Stock Price Sensitivity

Kevin Aretz
,
University of Manchester
Hassan Ilyas
,
Cornell University
Gaurav Kankanhalli
,
University of Pittsburgh

Abstract

We develop a real options investment model in which managers learn about the unobservable characteristics of new production technologies from their most recently installed production capacity and their firm’s stock price. Critically, the model predicts that managers rely more on the stock price the longer ago the firm last installed capacity. In accordance, the corporate investment-to-stock price sensitivity rises with past capacity overhang, a proxy for the time since a firm last acquired capacity. The results hold under various investment, employment, and Tobin’s Q proxies and controlling for the private information in stock prices and firm financial constraints. Notably, the disinvestment-to-stock price sensitivity falls with capacity overhang, suggesting managers also learn about liquidation values from stock prices. We shed light on the nature of information managers extract from markets by providing causal evidence that the managerial learning dynamics we uncover are more pronounced for firms exposed to greater technological progress.

Investor Demand, Firm Investment, and Capital Misallocation

Jaewon Choi
,
University of Illinois-Urbana-Champaign
Xu Tian
,
University of Georgia
Yufeng Wu
,
University of Illinois-Urbana-Champaign
Mahyar Kargar
,
University of Illinois-Urbana-Champaign

Abstract

Fluctuations in investor demand dramatically affect firms' valuation and access to capital. To quantify their real impacts, we develop a dynamic investment model that endogenizes the demand- and supply-side of equity capital. Strong demand dampens price impacts of issuance, facilitating investment and financing, while weak demand encourages opportunistic repurchases, crowding out investment. We estimate the model using indirect inference by matching the endogenous relationship between investor demand and firm policies. Our estimation suggests that investor demand is an important driver of misallocation, compared with financial and real frictions and heterogeneous risk premia. Eliminating excess demand reduces dispersion in the marginal product of capital by 23.8% and productivity losses by 22.3%. With demand fluctuations, firms hold higher cash savings and tend to be larger---excess demand allows firms with financial market power to profit from financial market transactions, contributing to the emergence of superstar firms.

News from Afar: The Information Role of Nonlocal Investors in Guiding Investment Decisions

Ray Gao
,
University of Rochester
Xixi Xiao
,
University of Rochester

Abstract

This study examines how nonlocal investors facilitate managers’ decision-making via stock prices (managerial learning). Due to geographical proximity to their immediate surroundings, nonlocal investors have useful information unknown to remote managers, potentially contributing to more managerial learning. In the general investment setting, we predict and find higher investment-q sensitivity when investors are more distant from firms’ headquarters. This relation is stronger in firms with greater geographic complexity, more informed trading, and less informed managers. We further show that nonlocal investors located in investment-relevant states drive the result. In the M&A setting, we find that the probability of deal completion is more sensitive to market reactions to deal announcements when acquirers (i.e., managers) are far from the target and investors are close to the target. Finally, we address the endogeneity issue by exploiting two exogenous shocks that affect the relative information advantage of nonlocal investors over managers to establish causality. Collectively, our evidence suggests that managers learn from the information impounded by nonlocal investors when making investment decisions. The paper broadly speaks to the unique information role played by nonlocal investors in enhancing revelatory price efficiency.

Discount Rates: Measurement and Implications for Investment

Niels Gormsen
,
University of Chicago
Kilian Huber
,
University of Chicago

Abstract

Standard theory implies that the discount rates used by firms in investment decisions play a key role in determining investment and transmit shocks to asset prices and interest rates to the real economy. However, there exists little evidence on how corporate discount rates change over time and affect investment. We construct a new global database of firms’ discount rates based on manual entry from earnings conference calls. We show that corporate discount rates move with the cost of capital, but the relation is less than one-to-one, leading to time-varying wedges between discount rates and the cost of capital. The average wedge has increased substantially over the last decades as the cost of capital has dropped. Discount rate wedges are negatively related to future investment, with a magnitude close to that predicted by theory. Moreover, the large and growing discount rate wedges can account for low investment (relative to high asset prices) in recent decades. We find that risk and the combination of market power and beliefs about value creation explain levels and trends of discount rate wedges.

Discussant(s)
Jesse Davis
,
University of North Carolina-Chapel Hill
Yao Zeng
,
University of Pennsylvania
Sebastien Michenaud
,
DePaul University
Olivier Dessaint
,
INSEAD
JEL Classifications
  • G3 - Corporate Finance and Governance