Do Stock Price Bubbles Influence Corporate Investment?

Building on recent developments in behavioral asset pricing, we develop a model in which an increase in the dispersion of investor beliefs under short-selling constraints predicts a rise in stock price above its fundamental value, or bubble. The model predicts managers respond to bubbles by issuing new equity and increasing capital expenditures. We test these predictions (among others) using the variance of analysts’ earnings forecasts – a proxy for the dispersion of investor beliefs – to identify the “bubble” component in Tobin’s Q. When comparing firms traded on NYSE vs NASDAQ, we find that our model does well at capturing key features of the 1990’s technology boom. We provide further evidence in favor of our model using a panel-data VAR framework. We …nd that orthogonalized shocks to dispersion have positive and statistically significant effects on Tobin’s Q, net equity issuance, and real investment, consistent with the predictions of the model