Feedback Effects and Systematic Risk Exposures

Snehal Banerjee, Bradyn Breon‐drish and Kevin Smith

Journal of Finance, 2025, vol. 80, issue 2, 981-1028

Abstract: We model the “feedback effect” of a firm's stock price on investment in projects exposed to a systematic risk factor, like climate risk. The stock price reflects information about both the project's cash flows and its discount rate. A cash‐flow‐maximizing manager treats discount rate fluctuations as “noise,” but a price‐maximizing manager interprets such variation as information about the project's net present value. This difference qualitatively changes how investment behavior varies with the project's risk exposure. Moreover, traditional objectives (e.g., cash flow or price maximization) need not maximize welfare because they do not correctly account for hedging and risk‐sharing benefits of investment.

Date: 2025
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https://doi.org/10.1111/jofi.13427

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Persistent link: https://EconPapers.repec.org/RePEc:bla:jfinan:v:80:y:2025:i:2:p:981-1028

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