Shareholder-Manager Disagreement, Animal Spirits, and Corporate Investment

Abstract:     
We develop a theoretical model in which disagreement between management and shareholders creates a link between investment and the stock market. We show that the stock price decreases in the level of disagreement. Because management uses the stock price to infer the level of disagreement, the firm's investment is positively correlated with its stock price, even when investment is not financed by an equity issue. Empirically, we find that Tobin's q is negatively related to a proxy for disagreement. This proxy is unrelated to traditional indicators of asymmetric information. Using simple estimation of an investment Euler equation, we find first that a high stock price and a low level of disagreement act together to increase investment today relative to investment tomorrow. We conclude that disagreement drives corporate investment to a much greater extent than either asymmetric information or managerial entrenchment.

Keywords: Disagreement, Investment, Stock Price, Financial Flexibility, Managerial Entrenchment

JEL Classifications: G31, E22, G32, G34

Working Paper Series