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Capital Investments and Stock Returns

Published online by Cambridge University Press:  06 April 2009

Sheridan Titman ,
K. C. John Wei  and
Feixue Xie
Sheridan Titman
Affiliation:
titman@mail.utexas.edu, Department of Finance, University of Texas at Austin, Austin, Texas 78712
K. C. John Wei
Affiliation:
johnwei@ust.hk, Department of Finance, Hong Kong University of Science and Technology, Clearwater Bay, Kowloon, Hong Kong
Feixue Xie
Affiliation:
fxie@utep.edu, Department of Economics and Finance, College of Business Administration, University of Texas at El Paso, El Paso, TX 79968
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Abstract

Firms that substantially increase capital investments subsequently achieve negative benchmark-adjusted returns. The negative abnormal capital investment/return relation is shown to be stronger for firms that have greater investment discretion, i.e., firms with higher cash flows and lower debt ratios, and is shown to be significant only in time periods when hostile takeovers were less prevalent. These observations are consistent with the hypothesis that investors tend to underreact to the empire building implications of increased investment expenditures. Although firms that increase capital investments tend to have high past returns and often issue equity, the negative abnormal capital investment/return relation is independent of the previously documented long-term return reversal and secondary equity issue anomalies.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 39 , Issue 4 , December 2004 , pp. 677 - 700
Copyright
Copyright © School of Business Administration, University of Washington 2004

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