Capital Investments and Stock Returns

Abstract

Firms that substantially increase capital investments subsequently achieve negative benchmarkadjusted 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.

Testing the Relationship between Free Cash Flow and Company Performance in Borsa Istanbul

“…Inverse relationship between free cash flow under the control of managers and performance demonstrates that the fundamental argument of the free cash flow hypothesis is valid in the Turkish context. These results are compatible with the findings of Titman et al (2003), Fairfield et al (2003), Dechow et al (2008), Park and Jang (2013), Heydari et al (2014), Brush et al (2000) and Wang (2010). The hypothesis argues that using external debt financing and dividend payout reduces the amount of free cash flow in the hands of managers.…”

“…The thesis that external financing or dividends reduce free cash flow available to managers has been empirically supported by Lang, Ofek, and Stulz (1996), Li and Cui (2003), Byrd (2010), Khan, Kaleem, and Nazir (2012), Fatma andChichti (2011) andZhang (2009) and by Kadioglu and Yilmaz (2017) in the Turkish context. Titman et al (2003), Fairfield et al (2003) and Dechow et al (2008) put forth that in the case of free cash flow in the control of managers or overinvestment with these funds, company performance is negatively affected. Studies conducted by Park and Jang (2013), Heydari et al (2014), Brush et al (2000) and Wang (2010) found a negative relationship between free cash flow and performance.…”

“…Debt financing or dividend payouts reduce free cash flow, having a positive effect on company performance. Titman, Wei, and Xie (2003), Fairfield, Whisenant, and Yohn (2003) and Dechow, Richardson, and Sloan (2008) argued that company performance is negatively affected by overinvestment using free cash flow under managers' control. The work of Park and Jang (2013), Heydari, Milad, and Javadghayedi (2014), Brush, Bromiley, and Hendrickx (2000) and Wang (2010) also revealed a negative correlation between performance and free cash flow.…”

Major Investments, Firm Financing Decisions, and Long-Run Performance

“…However, neither Richardson and Sloan [2003] nor Titman, Wei, and Xie [2003] controls for the firm's financing source. Our sample permits us to separate the effects of investment and financing on long-run performance.…”

When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms

“…In a recent paper, Titman, Wei and Xie [2001] do this kind of forecasting exercise explicitly, demonstrating that one can earn high benchmark-adjusted returns by buying the stocks of low-investment firms and shorting the stocks of high-investment firms. They are interested in a different set of issues than we are, however, and so they do not explore the cross-sectional predictions that we focus on.…”