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Discussion paper

Smells like animal spirits: the effect of corporate sentiment on investment

Publisher
Business conditions Business investment Australia
Description

Economists have long been interested in the effect of business sentiment on economic activity. Using text analysis, the author constructs a new company-level indicator of sentiment based on the net balance of positive and negative words in Australian company disclosures. He finds that company-level investment is very sensitive to changes in this corporate sentiment indicator, even controlling for fundamentals, such as Tobin's Q and expected profits, as well as controlling for measures of company-level uncertainty.

The author explores the mechanisms that link investment to sentiment. The conditional relationship could be because sentiment proxies for private information held by managers about the future prospects of the company or because of animal spirits among managers relative to investors. He finds that the effect of sentiment on investment is relatively persistent, which is consistent with the private information story, albeit less persistent than other news shocks, such as Tobin's Q. But the effect of sentiment on investment is not any stronger at ‘opaque’ companies in which managers are likely to be better informed than investors, which argues against the private information story.

Corporate investment has been weak in Australia since the global financial crisis (GFC) and demand-side factors, such as lower sales growth, explain more than half this persistent weakness. Low sentiment and heightened uncertainty weighed on investment during the GFC but have been less important factors since then.

Publication Details
License type:
CC BY
Access Rights Type:
open
Issue:
RDP 2021-11