Private Firm Investment and Public Peer Misvaluation

• In Event: Financial Reporting and Capital Markets

Abstract

We examine whether misvaluation of publicly traded firms affects capital expenditure investments by privately-held firms. The economic competition hypothesis predicts a negative relation because misvaluation-induced new investment by public firms crowds out investment by private firms when they share common input or output markets. Alternatively, the shared-sentiment hypothesis predicts a positive relation because sentiment driving misvaluation in public markets is shared by private firm stakeholders, which affects investments in private firms. Our results are consistent with the shared-sentiment hypothesis. Moreover, our findings indicate that misvaluation-induced investment is not financed with equity for private firms, but rather with internal funds and/or new debt. Interestingly, misvaluation-induced investment incrementally increases future return on investment for private firms, in contrast to a decrease for public firms. Overall, overvaluation in public markets has a beneficial effect on investments of private firms.

Authors

• Brad Badertscher, University of Notre Dame

• Devin M Shanthikumar, University of California-Irvine

• Siew Hong Teoh, University of California-Irvine