New publication | The Impact of Stock Price Fragility on Corporate Financial Behavior: Evidence and Implications
The interplay between financial markets and firms' decision-making processes is intricate and firms navigate a landscape where stock prices can be influenced by various factors, including non-fundamental shocks originating from investor behavior. This prompts a fundamental question: How do firms adapt to changes in their exposure to non-fundamental price movements, often referred to as stock price fragility?
This paper delves into this question and develops a model that examines corporate responses to higher potential for future stock market misvaluation. Using data from a large set of US firms (2001-2017) it then documents that within-firm variation in stock price fragility has effects in line with the model: higher fragility raises cash holdings and lowers investment. Closer examination of a number of instances where stock price fragility exogenously changes for firms provide further support for the that the mechanisms on which the model relies are important empirically.
The paper is coauthored with Itay Goldstein (Wharton) and Kristine Hankins (U Kentucky).
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Abstract
This study shows that firms regard stock price fragility - exposure to non-fundamental demand shocks stemming from the composition of equity ownership - as a salient corporate risk. We model ex ante corporate responses to higher potential for future stock market misvaluation and then empirically document that within firm variation in equity fragility has effects in line with the model: higher fragility raises cash holdings and lowers investment. Multiple natural experiments support a causal interpretation of the results. The results are shown to be more prominent in the face of high uncertainty and financial constraints. The evidence presents a new dimension of how managerial expectations affect corporate policies.
