RDP 2021-11: Smells Like Animal Spirits: The Effect of Corporate Sentiment on Investment 6. Policy Implications and Conclusions

In this paper I develop new company-level indicators of corporate sentiment and uncertainty based on text analysis of corporate annual reports. I show that corporate sentiment has a statistically significant and robust positive association with company-level investment, even controlling for fundamentals and measures of uncertainty. Estimates from local projections suggest that the effect of sentiment on investment is less persistent than that of a fundamentals shock, as measured by Tobin's Q, which suggests that the link between sentiment and investment is at least partly reflective of animal spirits amongst corporate managers. The decline in sentiment and increase in uncertainty contributed to the weakness in investment during the GFC, but other demand-side factors such as sales growth are more important in explaining the persistent weakness in corporate investment observed since then.

For policymakers, the results suggest that external communications may have real effects on the economy by influencing sentiment among corporate managers, even if fundamental factors are unaffected. Given the strong correlation between sentiment and investment at the company level, for policymakers, it may be worth investing more resources in behavioural macroeconomic models that allow for exogenous shocks to expectations amongst households and business decision-makers. Previous research has shown that, in such models, strict inflation targeting (as opposed to a more flexible approach based on average inflation over a longer period) can be suboptimal because it gives more scope for endogenous business cycle fluctuations that can destabilise inflation and output growth (De Grauwe 2011).

This paper focuses on the sentiment expressed in the text of corporate disclosures, which necessitates a focus on publicly listed companies, which are a very small and potentially biased sample of the business population. Therefore, there may be benefits to investing in panel surveys of the broader business population which survey expectations and uncertainties about future sales, employment and investment (similar to the Survey of Business Uncertainty in the United States, run by the Federal Reserve Bank of Atlanta).

The paper relies on a very simple text analysis approach to capture sentiment amongst companies. It may be worth exploring more sophisticated approaches that better capture the nuances of the language of economics and finance (Consoli, Barbaglia and Manzan 2020) or that capture the emotion as well as the tone of the language.