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Corporate finance
In this section, the reports deal with articles on corporate finance: capital structure, corporate financial policy, IPOs, share buybacks, CEO compensations, stock options, managerial incentives, debt issuance, tax issues, the empirical studies etc..

Investor Sentiment and Corporate Finance: Micro and Macro

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In this paper, the authors suggest to test whether behavioral finance or rational markets can explain the comovement of stock issuance and merger activity with the equity market. 

They use the fact that the stock market seems to be inefficient in time series (more market sentiment) but efficient in cross-section (more rational). For instance, Campbell (1991) finds that less than half of the innovation in stock market returns is not because of changes in future cash flows but because of changes in the future risk premium. On the contrary, Vuolteenaho (2002) finds that at the firm level,  most of innovation in stock market returns is because of changes in future cash flows. 

Therefore, they examine the response of stock issuance and merger activity to aggregate stock returns and firm-level stock returns. If aggregate stock returns dominate, they take it as evidence for the behavioral explanation. 

They run bivariate regressions of individual firm equity stock issuance, merger activity (using a dummy variable) and the ratio of capital expenditures to net property plant and equipment (all annual variables) on: 

(i)                   The aggregate and idiosyncratic stock returns (past three month returns)

(ii)                 The aggregate market-to-book value ratio and the firm-level market-to-book value ratio (previous year)  

They find that the aggregate variables are significant and have a greater impact on the firm stock issuance and merger activity, less so on the firm investment. 

They infer that their findings support the behavioral explanation over the rational market explanation. 

We think that this indirect way of testing is not entirely convincing. Several explanations could be consistent with the larger effect of the aggregate market returns over the firm-level return, for instance: 

-          Even though firm fundamentals might be positive, stock issuance might not happen because debt issuance or bank debt might be cheaper especially when the whole stock market is down. 

-           The aggregate stock returns might reflect aggregate market liquidity or changes in the business cycle more accurately than firm-level stock returns and therefore be more significant in explaining corporate finance policy 

-          There are evidence of rational merger waves due to prisoner dilemma behavior, therefore a decision to merge might not be entirely dependent on firm-specific information.   

Campbell, John Y. “A Variance Decomposition for Stock Returns.” Economic Journal,March 1991, 101(405), pp. 157-179. 

Owen A. Lamont and Jeremy C. Stein, 2007, “Investor Sentiment and Corporate Finance: Micro and Macro”, Harvard University, 

Vuolteenaho, Tuomo. “What Drives Firm-Level Stock Returns?” Journal of Finance,February 2002, 57(1), pp. 233-264. 


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