A Catering Theory of Investment Policies. Do U.S. firms cater to sentiment?

Abstract: The purpose is to investigate retail investors’ growing influence in shaping corporate investment policies. It further seeks to understand whether firms cater to retail investor sentiment. We employ a multiple linear regression model of a strongly-balanced panel data set, incorporating fixed effects and clustered standard errors. We construct a Financial and Economic Attitudes Revealed by Search (“FEARS”) index by aggregating U.S. households' Google search volume data to measure retail investor sentiment. To support our analysis, we review various relevant theories, including market timing, catering, prospect, and herd behavior theories. Empirical foundation: Our sample data was retrieved from Bloomberg. It consists of 23,712 quarterly observations on 741 publicly listed firms on the Nasdaq Composite. In a subsample analysis, we find a significant positive relationship between retail investor sentiment and investment activities before and after the onset of the pandemic. Further, we find an inverse relationship between the FEARS index and VIX, suggesting that retail and institutional investors may influence corporate investment activities differently.