Essays on Macroeconomic Expectations and Corporate Investment

Abstract

This dissertation studies how biased expectations and risk aversion affect the real economy. Collectively, these essays argue and present empirical evidence that the “animal spirits,” in the form of biased expectations and risk aversion, affect the investment and hiring decisions of firms as well as the behavior of individuals. In the first essay, I show that managers overweight observations of local economic conditions at firm headquarters (HQ) when forming their macroeconomic expectations. I find that HQ local economic conditions have excessive impacts on investment and employment growth, even at firm establishments far from HQ. Then, I show that HQ local conditions are overweighted in managers’ expectations. Worse HQ local conditions lead to more pessimistic sales forecasts and more negative macroeconomic sentiment. These findings support the notion that local economic conditions bias managers’ macroeconomic expectations and affect the real economic choices of firms. In the second essay, I show that risk aversion amplifies business cycle downturns, by studying the risk exposure of CEOs and its effect on firm investment in times of high macroeconomic uncertainty. Exploiting exogenous variation in CEO equity ownership, I find that firms with larger CEO stakes decrease investment significantly more in periods of high uncertainty. I consider whether better shareholder alignment explains this finding, but do not find evidence supporting this explanation. Firms with high institutional ownership do not cut investment more in times of high uncertainty. In addition, firms with high CEO stakes decrease risk-taking in times of high uncertainty, and experience lower stock returns subsequent to periods of high uncertainty. These results support the management risk aversion explanation. In the final essay, I show that local conditions overweighting occurs in other contexts too. First, I find that presidents of regional Federal Reserve Banks vote for more “hawkish” monetary policy if their city’s inflation rate is higher. I argue that this result is consistent with local conditions overweighting, and do not find evidence that this is driven by their preferences for monetary policy to be regionally optimal. Second, I show that households have a more pessimistic outlook on the national economy and future stock market returns if local economic conditions are worse.