Private Firm Investment and Public Peer Valuation and Sentiment

We examine whether private firm investments are sensitive to misvaluation and investor sentiment about public firms. Previous research finds that public firms respond to overvaluation and high investor sentiment by increasing investments. However, private firms have weaker incentives to cater to investor overoptimism and are less able to exploit overvaluation by issuing overvalued equity. We find that private firms have lower investment sensitivity than public firms to misvaluation and investor sentiment. The difference is largest when growth opportunities are highest. Private firms use new debt financing to fund investment increases in response to public peer overvaluation or high sentiment whereas public firms use both new debt and equity financing. Furthermore, we find that subsequent to periods of overvaluation or high sentiment, private firms experience higher returns on investments whereas public firms experience lower returns. Overall, the evidence suggest that Jensen’s agency theory of overvalued equity applies to public firms but not private firms.

This seminar is organised by the Erasmus Accounting Research Group.