New York University, Stern School of Business - Does the Stock Market Harm Investment Incentives?
May 9, 2010
Does the Stock Market Harm Investment Incentives? * †
John Asker
New York University
Stern School of Business
Joan Farre-Mensa
Stern School of Business
Department of Economics
New York University
Alexander Ljungqvist
New York University
Stern School of Business
ECGI and CEPR
May 9, 2010
* We are grateful to Sageworks Inc. for access to their database on private companies, and to Drew White and Tim Keogh of Sageworks for their help and advice regarding their data.
† Address for correspondence: New York University, Stern School of Business, Suite 9-160, 44 West Fourth Street, New York NY 10012-1126. Phone 212-998-0304. Fax 212-995-4220. e-mail al75@nyu.edu.
Does the Stock Market Harm Investment Incentives?
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.
Key words: Corporate investment; Short-termism; Empire building; Managerial incentives;
Agency problems; Private companies; IPOs.
JEL classification: D21; G31; G32; G34.