Investor Sentiment, Executive Compensation, and Corporate Investment
Posted: 4 Aug 2009 Last revised: 15 Aug 2010
Date Written: August 2, 2009
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.
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