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Importance of Catering Incentives for Growth Dynamics

This paper tests whether the dynamics of firm growth metrics, such as sales and investment growth, are consistent with firms catering to the market by delivering growth when stock prices are more sensitive to growth-related news. After developing growth valuation premium measures, we document four main results consistent with catering theory. First, time periods of high growth premium are followed by higher-than-expected growth indicators. Second, catering to the premium is more pronounced for firms whose managers care more about maximizing short-term stock prices. Third, firms whose managers care more about short-term stock prices have higher time-series volatility of median sales, investment, and PPE growth. Finally, conditional trading strategy based on timing the revenue growth premium yields 26 basis points per month after adjusting for risk and postearnings announcement drift.