Catering Through Nominal Share Prices

Abstract

We propose and test a catering theory of nominal stock prices. The theory predicts that when investors place higher valuations on low-price firms, managers will maintain share prices at lower levels, and vice-versa. Using measures of time-varying catering incentives based on valuation ratios, split announcement effects, and future returns, we find empirical support for the predictions in both time-series and firm-level data. Given the strong cross-sectional relationshipbetween capitalization and nominal share price, an interpretation of the results is that managers may be trying to categorize their firms as small firms when investors favor small firms.