Ripple Effects of Noise on Corporate Investment.

Summary Firms significantly reduce their investment in response to non-fundamental drops in the stock price of their product-market peers. We argue that this result arises because of managers' limited ability to filter out the noise in stock prices when using them as signals about their investment opportunities. The resulting losses of capital investment and shareholders' wealth are economically large, and affect even firms that are not facing severe financing constraints or agency problems. Our findings offer a novel perspective on how stock market inefficiencies can affect the real economy, even in the absence of financing or agency frictions.