The Real Effects of Investor Sentiment

Christopher Polk, Paola Sapienza

NBER Working Paper No. 10563
Issued in June 2004
NBER Program(s):   AP   CF   EFG

We study how stock market mispricing might influence individual firms' investment decisions. We find a positive relation between investment and a number of proxies for mispricing, controlling for investment opportunities and financial slack, suggesting that overpriced (underpriced) firms tend to overinvest (underinvest). Consistent with the predictions of our model, we find that investment is more sensitive to our mispricing proxies for firms with higher R&D intensity suggesting longer periods of information asymmetry and thus mispricing) or share turnover (suggesting that the firms' shareholders are short-term investors). We also find that firms with relatively high (low) investment subsequently have relatively low (high) stock returns, after controlling for investment opportunities and other characteristics linked to return predictability. These patterns are stronger for firms with higher R&D intensity or higher share turnover.

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