Catering Through Nominal Share Prices
46 Pages Posted: 3 Nov 2008
Date Written: January 2007
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.
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