The existing research focuses on two channels how stock (mis-)pricing influences firm investment. On the one hand, the informational role of prices is examined. The general conclusion shared by many papers is as follows: managers learn from high prices that the aggregated opinion of investors sees promising investment opportunities. Hence, decision makers invest because they either learn from actual new information or they want to cater the investors and keep the stock prices high because of personal incentives.
On the other hand, the financing role of equity is investigated. Many papers come to the same conclusion. Mispriced stocks are equal to misvalued eq-uity. Consequently, if stocks are overpriced the cost of financing through issuance of new shares declines. If the cost of financing declines, more in-vestment opportunities seem to be promising. Therefore, the firm’s investment activity increases. Additionally, third parties and potential debt lenders like banks evaluate the firm based on the stock performance amongst other aspects. If the stock price is high banks are more likely to issue credit and reduce their demands concerning the terms of debt (e.g. decrease inter-est rate). This is particularly important for financially constrained firms which are only able to invest in new projects if they are able to raise capital on their own.
By following the approach of Polk and Sapienza (2009, pp. 191-194), my thesis examines if the relation of firm investment to stock mispricing is influenced by market concentration. At first, I regress firm investment on mispricing, investment opportunities and cash flow proxies on my whole sample. Afterwards I build sub samples based on market concentration and conduct the same regression on those sub samples again. Thereby, my re-search adds the dimension of market competition to the existing research.
The thesis is organized as follows. In section 2 I briefly sum up the status quo in terms of research on the relation between mispricing and investment behavior. I state and explain my hypotheses in my third chapter. Following the explanations, I describe the data and methodology further in section 4. After evaluating my empirical results and documenting my robustness tests in section 5, I present my conclusions in chapter 6.
Table of Contents
1 Introduction
2 Literature Overview
2.1 Effect of Stock Price Evaluation on Firm Investment
2.1.1 Informational Channel
2.1.2 Equity-Channel
2.2 Reasons and Effects of Mispricing in Competitive Markets
3 Hypotheses
4 Methodology
4.1 Data
4.2 Empirical Framework
5 Empirical Results
5.1 Findings
5.2 Robustness Tests
6 Conclusion
Research Objectives and Key Topics
This thesis examines the relationship between stock price mispricing and real firm investment, specifically investigating how industry concentration influences this connection. The research seeks to identify whether firms in competitive industries exhibit higher sensitivity to stock mispricing when making investment decisions compared to firms in more concentrated environments.
- Analysis of informational and equity-based channels of investment
- Impact of market competition on corporate investment behavior
- Empirical testing using discretionary accruals as a proxy for mispricing
- Evaluation of industry concentration via Herfindahl index calculations
Excerpt from the Book
Informational Channel
Starting with the theoretical model of Dow and Gorton (1997), many empirical studies find evidence of an informational channel. The majority of economists also analyzes different ways of how managers benefit from information within the stock price as well as from different types of information.
Dow and Gorton (1997) develop a model in which managers can learn from the information given in the stock price. They show how shareholders can indirectly guide the managers’ decisions, such as firm investments. Hence the stock price is formed by the aggregated information of all shareholders. In case the stock price is high, Dow and Gorton argue, the shareholders evaluate the upcoming investment opportunities as promising. If managers have the right incentives (e.g. contracts based on future stock returns) to overcome agency problems, they will act according to the shareholders’ will. Dow and Gorton (1997, p. 1090) show in their model that also shareholders need incentives (e.g. observing that managers learn from their information) to produce information. Furthermore, they prove that price efficiency does not necessarily lead to economic efficiency. For instance, if the price contains no information, Dow and Gorton argue, the managers may not invest. Of course, if there is no investment, investors do not have any incentives to produce information. However, the price is efficient in this scenario while the economy is inefficient. To sum it up, Dow and Gorton (1997, p. 1089) emphasize on two types of information embedded in the stock price. On the one hand the forecasting information about future investment opportunities and on the other hand retrospective information about managers’ past decisions.
Summary of Chapters
1 Introduction: Introduces the research gap regarding how industry concentration affects the relationship between stock mispricing and real firm investment.
2 Literature Overview: Provides a theoretical foundation by discussing the informational channel and the equity-channel as primary drivers of firm investment.
3 Hypotheses: Formulates the two central hypotheses concerning the sensitivity of investment to mispricing and the moderating effect of industry competition.
4 Methodology: Details the data collection process from Compustat and the empirical regression model used to test the hypotheses.
5 Empirical Results: Presents the statistical findings, showing a significant positive relation between mispricing and investment, which is stronger in competitive industries.
6 Conclusion: Summarizes the findings, confirming that industry concentration enhances the investment sensitivity to stock mispricing.
Keywords
Stock Mispricing, Firm Investment, Industry Concentration, Informational Channel, Equity-Channel, Discretionary Accruals, Tobin’s Q, Herfindahl Index, Corporate Finance, Market Competition, Capital Expenditure, Investment Sensitivity, Financial Constraints, Empirical Analysis, Market Efficiency
Frequently Asked Questions
What is the core focus of this research?
The work investigates the link between stock price mispricing and real investment decisions made by firms, specifically exploring how industry concentration impacts this relationship.
What are the primary theoretical themes discussed?
The thesis centers on two main mechanisms: the informational channel, where managers use stock prices to infer investment opportunities, and the equity-channel, where mispricing affects the cost of capital and financing.
What is the central research question?
The study asks how industry concentration influences the relationship between stock mispricing and real firm investment.
Which scientific methodology is employed?
The author uses a linear regression model, utilizing discretionary accruals as a proxy for mispricing, and employs the Herfindahl index to categorize industries based on their level of concentration.
What topics are covered in the main body?
The main body covers a comprehensive literature review, the derivation of hypotheses, the empirical framework (data and regression setup), and the analysis of results including robustness tests.
Which keywords best describe this study?
Key terms include Stock Mispricing, Industry Concentration, Informational Channel, Corporate Investment, and Discretionary Accruals.
Why is investment sensitivity higher in competitive industries?
The study suggests that firms in competitive markets rely more on common industry signals and public information, leading them to react more quickly to stock price changes to maintain competitive advantage.
How does the author define mispricing?
Mispricing is proxied using discretionary accruals, based on the approach established by Polk and Sapienza (2009).
What role does the Herfindahl index play in this study?
The index is used to measure industry concentration, allowing the author to split the sample into concentrated and competitive groups to test the second hypothesis.
- Quote paper
- Jonas Junk (Author), 2017, Mispricing of Stocks and Firm Investment in Competitive Industries. How Do They Influence Each Other?, Munich, GRIN Verlag, https://www.grin.com/document/540417
