Stock price informativeness, corporate expenditure and information asymmetry
thesisposted on 23.02.2017, 03:03 authored by Lee, Mei Yee
This study examines how firm-level corporate expenditure represented by R&D, capital expenditure (CAPEX) and selling, general and administrative (SGA) costs responds to stock price informativeness. Using data from the United States public listed companies for the years 2003 to 2009 covering the post-Sarbanes Oxley Act period, a current year’s stock price informativeness, proxied by idiosyncratic volatility, is found to be negatively associated with the subsequent year’s R&D expenditure and SGA costs. However, it was observed there is no relationship between a current year’s idiosyncratic volatility and CAPEX level of the subsequent year. Additional insights are revealed by using a change model which examines the relationship between changes in a current year’s stock price informativeness and changes in the subsequent year’s R&D and SGA expenditure. The results exhibit that when firm-level stock price informativeness is strengthening, a change in the current year’s idiosyncratic volatility is positively related to changes in R&D and SGA expenditure in the following year. When stock price informativeness is deteriorating, firm managers do not react immediately to modify R&D and SGA costs. This asymmetric cost response is attributable, in part, to the cost “stickiness” behaviour of firm managers when it comes to changing R&D investment and SGA costs. These managers may be reluctant to increase corporate expenditure when stock price informativeness worsens as they need to assess whether the declining idiosyncratic volatility is temporary or permanent in nature. It is found that firm managers will only react by intensifying R&D expenditure and SGA costs when it is critically compelling, that is, when the relative idiosyncratic volatility (1-R2) drops significantly by 20 per cent. This finding is consistent with the learning theory that managers learn about firms’ fundamental values from the market’s feedback and they incorporate this new private information to make efficient corporate decisions in R&D expenditure and SGA costs. However, this study finds that firm managers do not rely on the input from the capital markets to make their capital investment decisions. Given the significance of stock price informativeness in enhancing allocation of firms’ scarce resources, this study provides useful insights and understanding on how firms modify their corporate expenditure in response to changes in stock price informativeness. Further analyses show that the relationship between stock price informativeness and corporate expenditure is dependent on information asymmetry, proxied by firm size, analyst following and bid-ask spreads. The analyses highlight that managers respond and learn more quickly from the new firm-specific information available in small firms and in firms with low analyst following as well as in firms with high bid-ask spread. These findings are consistent with the learning theory and information asymmetry theory. Consequently, firm managers react more “aggressively” by altering R&D expenditure and SGA costs in the subsequent year as stock price informativeness of a current year changes.