Does the Stock Market Harm Investment Incentives?

58 Pages Posted: 19 Jul 2010

See all articles by John Asker

John Asker

UCLA

Joan Farre-Mensa

University of Illinois at Chicago - Department of Finance

Alexander Ljungqvist

Stockholm School of Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); Research Institute of Industrial Economics (IFN)

Multiple version iconThere are 2 versions of this paper

Date Written: June 2010

Abstract

We examine whether stock market-listed firms in the U.S. invest suboptimally due to agency costs resulting from separation of ownership and control. We derive testable predictions to distinguish between underinvestment due to rational “short-termism” and overinvestment due to “empire building.” Empirical identification relies on a proxy for optimal investment derived from a rich new data source on unlisted U.S. firms. Listed firms invest less and are less responsive to changes in investment opportunities compared to matched unlisted firms, especially in industries in which stock prices are particularly sensitive to current profits. Listed firms also tend to smooth their earnings growth and dividends and are reluctant to report negative earnings. These findings are consistent with short-termism and contrary to what one would expect if empire-building were the dominant agency problem in the stock market. Our results suggest that the stock market harms investment incentives, at least for the fast-growing companies in our sample.

Keywords: Agency problems, Corporate investment, Empire building, IPOs, Managerial incentives, Managerial myopia, Private companies, Short-termism

JEL Classification: D21, G31, G32, G34

Suggested Citation

Asker, John William and Farre-Mensa, Joan and Ljungqvist, Alexander, Does the Stock Market Harm Investment Incentives? (June 2010). CEPR Discussion Paper No. DP7857. Available at SSRN: https://ssrn.com/abstract=1640379

John William Asker (Contact Author)

UCLA ( email )

8283 Bunche Hall
Los Angeles, CA 90095-1477
United States

Joan Farre-Mensa

University of Illinois at Chicago - Department of Finance ( email )

2431 University Hall (UH)
601 S. Morgan Street
Chicago, IL 60607-7124
United States

Alexander Ljungqvist

Stockholm School of Economics ( email )

111 60 Stockholm
Sweden

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Research Institute of Industrial Economics (IFN) ( email )

Box 55665
Grevgatan 34, 2nd floor
Stockholm, SE-102 15
Sweden

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