Investor Sentiment and Firm Capital Structure

Shengfeng Li, Hafiz Hoque () and Jia Liu
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Shengfeng Li: University of Portsmouth
Hafiz Hoque: Swansea University
Jia Liu: University of Portsmouth

No 2022-01, Working Papers from Swansea University, School of Management

Abstract: We provide novel evidence of the role of investor sentiment in determining firms’ capital structure decisions from three perspectives: leverage ratio, debt maturity and leverage target adjustment. We find that when investor sentiment is high, firms increase their leverage ratios, supporting our contention that high investor sentiment increases firms’ debt capacity and facilitates the use of an aggressive leverage policy. Debt maturity is shorter in high sentiment periods, implying that firms are confident about future earnings and use shorter debt maturity to signal their financial solvency. Leverage target adjustment is faster in high sentiment periods, indicating a lower cost of external finance. Furthermore, the sentiment-leverage relationship sensitivity is greater for financially constrained firms. Our extended analysis determines that leverage-increasing firms generate lower stock returns subsequent to a period of high sentiment, offering practical insights into the economic consequences of increasing leverage in high sentiment periods on corporate value for investors. Our research advances the understanding of the impact of investor sentiment on firms’ financing decisions and stock returns.

Keywords: Investor sentiment; capital structure; leverage; debt maturity; debt capacity; speed of adjustment; stock returns (search for similar items in EconPapers)
JEL-codes: G31 G32 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2022-12-05
New Economics Papers: this item is included in nep-cfn and nep-fmk
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