The Mechanisms Underlying External Financing and Capital Expenditures: Insights from Firm-Level Optimism/Pessimism

44 Pages Posted: 31 Aug 2018 Last revised: 16 Apr 2020

See all articles by Lucile Faurel

Lucile Faurel

Arizona State University

Mark T. Soliman

University of Southern California - Marshall School of Business

Jessica Watkins

University of Notre Dame

Teri Lombardi Yohn

Emory University Goizueta Business School

Date Written: April 15, 2020

Abstract

Prior literature documents a positive (negative) relation between past (future) stock returns and both external financing and capital expenditures. There has been much debate in the literature regarding the mechanisms driving these relations. In this study, we employ both a stock’s extreme return momentum and extreme trading volume to capture firm-level overpricing (underpricing) due to investor favoritism (neglect). We find that favoritism (neglect) is positively (negatively) associated with external financing decisions, and that the previously documented negative association between external financing and future stock returns is more pronounced in periods of favoritism. In contrast, after controlling for external financing, the positive (negative) association between favoritism (neglect) and capital expenditure decisions is attenuated, and we do not find the previously documented negative relation between capital expenditures and future stock returns. These findings suggest that financing decisions, but not capital expenditure decisions, are associated with managers’ exploitation of investor mispricing.

Keywords: external financing, capital expenditures, mispricing, optimism, favoritism

JEL Classification: D24, G31, M41

Suggested Citation

Faurel, Lucile and Soliman, Mark T. and Watkins, Jessica and Yohn, Teri Lombardi, The Mechanisms Underlying External Financing and Capital Expenditures: Insights from Firm-Level Optimism/Pessimism (April 15, 2020). Kelley School of Business Research Paper No. 18-75, Available at SSRN: https://ssrn.com/abstract=3237123 or http://dx.doi.org/10.2139/ssrn.3237123

Lucile Faurel

Arizona State University ( email )

W.P. Carey School of Business
School of Accountancy, B267H
Tempe, AZ 85287
United States
(480) 965-6216 (Phone)

Mark T. Soliman

University of Southern California - Marshall School of Business ( email )

2250 Alcazar Street
Los Angeles, CA 90089
United States

Jessica Watkins

University of Notre Dame ( email )

384 Mendoza College of Business
Notre Dame, IN 46656
United States

Teri Lombardi Yohn (Contact Author)

Emory University Goizueta Business School ( email )

201 Dowman Drive
Atlanta, GA 30322
United States

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