Do Underpriced Firms Innovate Less?
44 Pages Posted: 21 Nov 2013
Date Written: November 20, 2013
This paper finds that stock underpricing triggers underinvestment in research. To identify underpricing, I build on previous literature on liquidity induced trading pressure to develop an exogenous proxy of mispricing. This measure is based on funds that underperform because of their over-exposure to an economically distressed industry and are forced to sell stocks of healthy firms in unrelated industries for liquidity reasons. As a consequence price drops below fundamentals and firms respond decreasing innovation activity. The main empirical explanation which is consistent with this finding is that underpriced firms prefer to divert resources from R&D into buying back their own shares at a discount, in particular when financially constrained and held by impatient shareholders.
Keywords: innovation, research, underpricing, share repurchases, mutual funds, firm policies, impatience
JEL Classification: G12, G31, G35, O31
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