Ripple Effects of Noise on Corporate Investment
64 Pages Posted: 26 Dec 2015 Last revised: 16 Dec 2016
Date Written: December 14, 2016
We show that firms significantly reduce their investment in response to non-fundamental drops in the stock price of their product-market peers. This spillover is consistent with the hypothesis that managers have limited ability to filter out the noise in stock prices when using these as a source of information. As predicted by this hypothesis, the influence of the noise in peers' stock prices on a firm's investment is stronger when peers' prices are more informative, and weaker when managers are better informed. Our findings suggest a new channel through which local non-fundamental shocks to stock prices have real effects.
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