Investor Demand, Firm Investment, and Capital Misallocation

Abstract

Fluctuations in investor demand dramatically affect firms' valuation and access to capital. To quantify their real effects, we develop a dynamic investment model, incorporating both the demand and supply sides of capital. Strong investor demand relaxes financial constraints and facilitates equity issuance and investment, while weak demand encourages opportunistic share repurchases, crowding out investment. We estimate the model using indirect inference, matching the endogenous relationship between investor demand and firm policies. Our estimation reveals that demand fluctuations are an important driver of firm-level investment and economy-wide capital misallocation, accounting for 23.8% of dispersion in MPK and 22.3% of productivity losses.

Keywords: investor demand, firm investment, capital misallocation, structural estimation, market timing.

JEL Classification: G30, G10, G20, E22