Abstract:
Firms reduce investment in
response to non-fundamental drops in the stock price of their product-marke
t peers, as predicted by a model in which managers rely on stock prices as
a source of information but cannot perfectly filter out noise in prices. Th
e model also implies the response of investment to noise in peers’ stock pr
ices should be stronger when these prices are more informative, and weaker
when managers are better informed. We find support for these predictions. O
verall, our results highlight a new channel through which non-fundamental s
hocks to the stock prices of some firms influence real decisions of other f
irms.