Discussion Paper Details

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Title: Does the Stock Market Harm Investment Incentives?

Author(s): John Asker, Joan Farre-Mensa and Alexander P. Ljungqvist

Publication Date: June 2010

Keyword(s): Agency problems, Corporate investment, Empire building, IPOs, Managerial incentives, Managerial myopia, Private companies and Short-termism

Programme Area(s): Financial Economics

Abstract: We examine whether stock market-listed firms in the U.S. invest suboptimally due to agency costs resulting from separation of ownership and control. We derive testable predictions to distinguish between underinvestment due to rational ?short-termism? and overinvestment due to ?empire building.? Empirical identification relies on a proxy for optimal investment derived from a rich new data source on unlisted U.S. firms. Listed firms invest less and are less responsive to changes in investment opportunities compared to matched unlisted firms, especially in industries in which stock prices are particularly sensitive to current profits. Listed firms also tend to smooth their earnings growth and dividends and are reluctant to report negative earnings. These findings are consistent with short-termism and contrary to what one would expect if empire-building were the dominant agency problem in the stock market. Our results suggest that the stock market harms investment incentives, at least for the fast-growing companies in our sample.

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Bibliographic Reference

Asker, J, Farre-Mensa, J and Ljungqvist, A. 2010. 'Does the Stock Market Harm Investment Incentives?'. London, Centre for Economic Policy Research.