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Does the Stock Market Harm Investment Incentives?

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  • Asker, John
  • Farre-Mensa, Joan
  • Ljungqvist, Alexander P.

Abstract

We examine whether stock market-listed firms in the U.S. invest suboptimally due to agency costs resulting from separation of ownership and control. We derive testable predictions to distinguish between underinvestment due to rational “short-termism” and overinvestment due to “empire building.” Empirical identification relies on a proxy for optimal investment derived from a rich new data source on unlisted U.S. firms. Listed firms invest less and are less responsive to changes in investment opportunities compared to matched unlisted firms, especially in industries in which stock prices are particularly sensitive to current profits. Listed firms also tend to smooth their earnings growth and dividends and are reluctant to report negative earnings. These findings are consistent with short-termism and contrary to what one would expect if empire-building were the dominant agency problem in the stock market. Our results suggest that the stock market harms investment incentives, at least for the fast-growing companies in our sample.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 7857.

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Date of creation: Jun 2010
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Handle: RePEc:cpr:ceprdp:7857

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Related research

Keywords: Agency problems; Corporate investment; Empire building; IPOs; Managerial incentives; Managerial myopia; Private companies; Short-termism;

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References

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Cited by:
  1. Campello, Murillo & Graham, John R., 2013. "Do stock prices influence corporate decisions? Evidence from the technology bubble," Journal of Financial Economics, Elsevier, vol. 107(1), pages 89-110.
  2. Behr, Patrick & Norden, Lars & Noth, Felix, 2013. "Financial constraints of private firms and bank lending behavior," Journal of Banking & Finance, Elsevier, vol. 37(9), pages 3472-3485.
  3. O’Connor, Matthew & Rafferty, Matthew & Sheikh, Aamer, 2013. "Equity compensation and the sensitivity of research and development to financial market frictions," Journal of Banking & Finance, Elsevier, vol. 37(7), pages 2510-2519.

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