Investor Sentiment and Real Investment

Sounds like a paper on quasi reflexivity – of course academics wouldn’t call it that.

Abstract (Via SSRN)

We study how investor sentiment affects real investment. Both investment and external finance increase significantly with sentiment. Sentiment appears to relax financing constraints; the relation between q and investment increases with sentiment, while the relation between internal cash flow and investment declines with sentiment. When firms invest in low sentiment states operational efficiency improves, but when firms invest in high sentiment states operational efficiency declines. Stock returns following investment made in high sentiment states are significantly lower than stock returns following investment made in low sentiment states. The findings suggest that investor sentiment creates inefficiencies in the allocations of both financial and real resources.

Excerpt (Via SSRN)

There are at least four avenues through which investor sentiment could influence real investment. First, if managers share the same sentiment towards the prospects of their firms as investors do, then investment should be increasing in sentiment. Second, as Morck, Shleifer, and Vishny (1990) point out, managers may infer information from share prices. A price inflated with sentiment could therefore cause managers to infer high expected cash flow or low discount rates, both of which would prompt more investment. Third, Polk and Sapienza (2009) contend that catering to investor beliefs via investment may increase short-term firm value. Hence investment due to catering should be increasing in market sentiment. Fourth, Stein (1996) and Baker, Stein, and Wurgler (2003) contend that firms in need of external finance may forego investment if their securities are undervalued, so for this reason too both investment and external finance should be increasing in sentiment.

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06. October 2009 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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