The impact of capacity expansion on the market value of the firm

Abstract

Abstract This paper empirically investigates the impact of capacity expansion decisions on the market value of the firm. Event study methodology is used to estimate the abnormal change in stock prices around capacity expansion decision announcements. On the day of the announcement, the magnitude of the price change is abnormally high, evidenced by a significantly positive mean standardized square of the abnormal change (Beaver's U‐statistic). We also analyze factors that we could affect the direction and magnitude of the abnormal change in the stock prices. We find that the change in price on the day of the announcement is positively and significantly related to the real growth rate of the industry, and negatively and significantly related to the variability of demand. A negative relationship between the price change and industry capacity utilization is also found which can have important implications for companies which follow the wait‐and‐see approach to capacity expansion decisions. We also find management ownership to be a significant predictor in explaining stock price changes around these announcements.