Private Firm Investment and Public Peer Misvaluation

Abstract

We examine whether misvaluation of publicly traded industry peers is associated with capital expenditures by privately-held firms. An economic competition hypothesis predicts a negative relation because misvaluation-induced new investment by public firms crowds out investment by private firms when they share common input or output markets. An alternative shared sentiment hypothesis predicts a positive relation because private firm stakeholders share in the sentiment associated with misvaluation in public markets. Misvaluation is proxied using both the price-to-fundamental ratio and an exogenous instrument obtained from mutual fund flows. The evidence is consistent with the shared sentiment hypothesis, and robust to alternative treatments for growth opportunities. We find expected cross-sectional variation in the strength of the positive relation between public-peer misvaluation and private firm investment. Our results indicate that private firms finance misvaluation-induced investment primarily internally or externally with debt, not equity. Finally, misvaluation-induced investment increases future return on investment for private firms in contrast with public firms. Overall, these findings suggest that overvaluation in public markets increases private firm investments and has beneficial effects on private firm investments by relaxing financing constraints.

Keywords: private firms, investment, misvaluation, overvaluation, catering pressure, debt issuance, equity issuance, agency costs

JEL Classification: G32, M41