We model the impact of public and private ownership structures on firms' incentives to invest in innovative projects. We show that it is optimal to go public when exploiting existing ideas and optimal to go private when exploring new ideas. This result derives from the fact that private firms are less transparent to outside investors than are public firms. In private firms, insiders can time the market by choosing an early exit strategy if they receive bad news. This option makes insiders more tolerant of failures and thus more inclined to invest in innovative projects. In contrast, the prices of publicly traded securities react quickly to good news, providing insiders with incentives to choose conventional projects and cash in early.

We find that Nevada, the second most popular state for out-of-state incorporations and a state with lax corporate law, attracts firms that are 30–40% more likely to report financial results that later require restatement than firms incorporated in other states, including Delaware. Our results suggest that firms favoring protections for insiders select Nevada as a corporate home, and these firms are prone to financial reporting failures. We provide some evidence that Nevada law also has a causal impact by increasing a Nevada firm's propensity to misreport financials after the firm has incorporated in Nevada.

Using bottom-up information from corporate financial statements, we examine the relation between aggregate investment, future equity returns, and investor sentiment. Consistent with the business cycle literature, corporate investments peak during periods of positive sentiment, yet these periods are followed by lower equity returns. This pattern exists in most developed countries and survives controls for discount rates, equity flows, valuation multiples, operating accruals, and other investor sentiment measures. Higher aggregate investments also precede greater earnings disappointments, lower short-window earnings announcement returns, and lower macroeconomic growth. We conclude aggregate corporate investment is an alternative, and possibly sharper, measure of market-wide investor sentiment.

We model the impact of public and private ownership structures on firms' incentives to invest in innovative projects. We show that it is optimal to go public when exploiting existing ideas and optimal to go private when exploring new ideas. This result derives from the fact that private firms are less transparent to outside investors than are public firms. In private firms, insiders can time the market by choosing an early exit strategy if they receive bad news. This option makes insiders more tolerant of failures and thus more inclined to invest in innovative projects. In contrast, the prices of publicly traded securities react quickly to good news, providing insiders with incentives to choose conventional projects and cash in early.