An empirical investigation of corporate investment decisions

This work adds to the literature which tries to explain how firm managers make corporate investment decisions. Using information on insider trades to understand how managers value their firms and investment opportunities is the main focus of analysis. Previous research on insider trading provides a background for this approach. Studies from the finance literature suggest that trades by upper-level management may be motivated by differences in the managers' and equity market's valuation of the firm's stock price. Thus we use insider trades as a proxy for the manager's estimate of the firm's stock-price misvaluation, and put this proxy into the standard corporate investment model: the investment q-theory equation. Under certain simplifying assumptions, q-theory states that the rate of investment depends on average q. Average q is the firm's market value---as measured by the equity market---divided by the replacement cost of its capital stock. Since it is the manager who makes the investment decisions, we test whether it is more appropriate to use the manager's valuation of the firm when constructing average q. Consequently, using the manager's estimate of the stock-price misvaluation in addition to the equity market valuation should better explain investment.;In chapter 1, we use insider ownership data from the Securities and Exchange Commission during the 1980s, and find that the percentage change in company shares held by the firm's insiders is positively and significantly correlated with investment. When insiders increase their holdings of company shares, investment is greater than what the stock price would predict. These results are driven by insider trades in small- and medium-sized firms; significant effects are not estimated for large firms. This result is consistent with the insider trading literature. Lakonishok and Lee (2001), for example, find that ex-post excess returns are largest for insiders trading in small firms.;In chapter 2, we test once again whether insider trading predicts firm-level investment for the 1996-2005 time period. A new SEC rule in 1992 increased the reporting requirements for executive ownership in annual proxy statements. Standard and Poor's subsequently began to collect this data in its Execucomp data set, which allows us to obtain a more detailed measure of executive firm ownership. The drawback of this data, however, is that it reports ownership for S&P 1500 firms only. Thus the analysis in the second chapter focuses on relatively larger, indexed publicly traded companies. We do find, however, support for our chapter 1 results. Insider trading during this later time period also significantly predicts firm investment. But unlike the analysis of chapter 1, the results are driven by executive sales of company shareholdings. Executive purchases of company shares do not predict investment.