Ripple Effects of Noise on Corporate Investment

Abstract

We show that firms reduce their investment in response to non-fundamental drops in the stock price of their product-market peers. This spillover is economically significant and consistent with the hypothesis that managers rely on stock prices as a source of information but cannot perfectly filter out the noise in these prices (the faulty informant hypothesis). As predicted by this hypothesis, the influence of the noise in peers' stock prices on a firm's investment is stronger when peers prices are more informative, and weaker when managers are better informed. Our findings suggest a new channel through which local non-fundamental shocks to the market valuation of a group of firms have real effects for other firms.