Investor Sentiment, Executive Compensation, and Corporate Investment

Posted: 4 Aug 2009 Last revised: 15 Aug 2010

See all articles by (Michael) Hui Li

(Michael) Hui Li

La Trobe University; Financial Research Network (FIRN)

Bruce D. Grundy

University of Melbourne

Date Written: August 2, 2009

Abstract

This paper investigates the relation between investor sentiment, executive compensation and corporate investment. We derive a model that shows the share price will be jointly affected by investor sentiment and the corporate investment decision. The model predicts that, if a compensation contract that includes long-term options or both long-term options and long-term restricted shares, the investment level increases with investors’ optimism. The model also predicts that the relation between investment level and the options or the shares in the firm depends on the value of parameters including investor sentiment and the fraction of the options or the fraction of the shares hold by the managers. We find no significant relation between investment level and the managers’ compensation, while a significant relation between investment level and investor sentiment as measured by share turnover. We also find if the compensation contract only includes options, then conditional on investor sentiment, the options have a negative relation with investment level. The result suggests that managers make investment decisions that cater for investor sentiment. The long-term option may be used to reduce the possible overinvestment given a high degree of investors’ optimism.

Suggested Citation

Li, (Michael) Hui and Grundy, Bruce D., Investor Sentiment, Executive Compensation, and Corporate Investment (August 2, 2009). Journal of Banking and Finance, Vol. 34, 2010, Available at SSRN: https://ssrn.com/abstract=1442922

(Michael) Hui Li (Contact Author)

La Trobe University ( email )

Department of Economics and Finance
La Trobe University
Melbourne, 3086
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Bruce D. Grundy

University of Melbourne ( email )

Faculty of Economics & Commerce
Department of Finance
Victoria, 3010
Australia
+61 3 8344 9083 (Phone)
+61 3 8344 6914 (Fax)

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