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Why does stock-market investor sentiment influence corporate investment?

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Abstract

We examine the relationship between corporate investment and investor sentiment at the firm level with the predicted change in investor sentiment. Empirically, we find that there is a large predictable mean reversion component in investor sentiment, and that a predicted increase in investor sentiment, capturing an unwinding of past market sentiment, positively affects the investment and debt issuance of firms with lower credit ratings, but not their equity issuance. Our results suggest that the positive relationship between investor sentiment and corporate investment may be due to that corporate managers are also driven by investor sentiment.

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Notes

  1. Our finding is consistent with previous studies on the role of managerial traits in explaining firms’ financing decisions See, for instance, Malmendier et al. (2011), Graham et al. (2013), and Ben-David et al. (2013).

  2. See also Balvers and Wu (2000, 2006), Chen and Kuo (2014), Szu et al. (2015), Baek (2016), Du and Zhao (2017), Ding et al. (2018), and Du and Hu (2018).

  3. For instance, as Baker and Wurgler (2007) point out, “A natural proxy for speculative appeal would be the dispersion of professional analysts’ earnings forecasts for that company” (p. 144). Avramov et al. (2009) find that firms with lower credit ratings often have higher forecast dispersion.

  4. See for instance Asquith and Mullins (1983), Korajczyk et al. (1991), Loughran and Ritter (1997), Baker and Wurgler (2002), and Huang and Ritter (2009).

  5. Baker et al. (2003) also find that equity-dependent firms with high investment tend to have low subsequent stock returns and high volume of equity issuance. See also Dittmar and Thakor (2007), Baker et al. (2009), and Chirinko and Schaller (2011).

  6. In addition, Campello and Graham (2013) find that constrained non-tech firms tend to save more cash from equity issuance than tech bubble firms. See also Almeida et al. (2004), Bolton et al. (2013), and Chen et al. (2019). See Caballero et al. (2006) and Jermann and Quadrini (2012) for theory.

  7. http://people.stern.nyu.edu/jwurgler/.

  8. https://www.hbs.edu/faculty/initiatives/behavioral-finance-and-financial-stability/Pages/sentiment.aspx.

  9. HY (high yield) = BB+, BB−, BB, B+, B, B−, CCC+, CCC−, CCC, CC, C, D; LIG (low investment grade) = A, A+, A−, BBB, BBB+, BBB−; HIG (high investment grade) = AAA, AA+, AA, AA−.

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Correspondence to Ding Du.

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The views expressed in this paper are those of the author, and do not necessarily reflect those of the Office of the Comptroller of the Currency, or the United States Department of the Treasury. Part of this research was conducted while Ding Du was visiting the Robert H. Smith School of Business, University of Maryland at College Park. The authors thank the editor Cheng-Few Lee and one anonymous referee for their valuable and insightful comments. The responsibility of any remaining errors is ours.

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Du, D., Hu, O. Why does stock-market investor sentiment influence corporate investment?. Rev Quant Finan Acc 54, 1221–1246 (2020). https://doi.org/10.1007/s11156-019-00823-6

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