The mood of a firm

Abstract

Mood is information. A good mood signals a desire to cooperate; a bad mood warns of a determination to oppose. Firms may communicate by mood. The paper makes three points about the mood of a firm. First, mood can change. A change in mood affects everyone in the market. Second, there exists a strong tendency for a firm frustrated by poor communication to have bad mood. Bad mood amplifies behavioral responses. Third, the attendant risks of bubbles and panics are a concern about policies that encourage firms to communicate by mood.

Introduction

Mood affects decisions. We buy more stocks on sunnier days (Saunders, 1993, Hirshleifer and Shumway, 2003). We also buy more stocks on days with lower temperature or longer daylight (Cao and Wei, 2005, Kamstra et al., 2003). Sunshine, temperature and daylight do not affect the fundamentals of most stocks; they affect stock prices because they affect our mood, and our mood affects the decisions we make.

Why do we pay attention to another person's mood? One reason is that it is informative. When we notice bad mood, we instinctively stay away from it. When we notice good mood, we feel drawn toward it. Mood tells us something about the potential consequences of social interaction.

As a way of communication, however, mood is not the most effective. Mood can be hard to express and difficult to read. Conversation and email are more effective. However, they may not be feasible, leaving mood to be the only means of communication. Casual observation suggests that people who are moody tend to have imperfect information about others’ intentions. Moody people often are isolated, finding it difficult to communicate openly and directly with others.

Another characteristic of mood is that it can be infectious. When one member of a group is in a good mood, other members feel an improvement in their moods right away. A bad mood spreads quickly as well. As Shiller, 1995, Shiller, 2005 observes, information cascade is especially likely to occur when the message being transmitted is subtle, understanding is shallow, and communication is poor. That explains why “social mood” is particularly likely to emerge in financial decisions (Hong et al., 2004, Hong et al., 2005, Nofsinger, 2005, Lucey and Dowling, 2005).

There is every reason to believe that, in markets where direct contact is very costly, firms will communicate by mood. Yet classical theories of the firm almost never recognize mood. One significant reason is that classical theories do not pay much attention to how firms actually communicate with each other. Behavioral theories of the firm, in contrast, are sharply focused on that question (Simon, 1982).

I have three objectives in this paper. First, I call attention to a paper by Leontief (1936) which contains a proof that the mood of a firm exists. The proof is notable because it is to my knowledge the first and only one in the tradition of classical theories, and because it has managed to remain totally obscure. I use the model in that paper to show that, if we ignore mood, we will not be able to predict well. For example, the entry of a firm causes the moods of existing firms to change and if we do not recognize that, then we will seriously underestimate the total effect of entry. The second objective is to identify limitations of mood as a way of communication, in light of behavioral theories. Because mood encourages herd behaviors and speculative bubbles, a market dependent on mood for communication is inherently unstable. Lastly, I draw out the implication that antitrust policy is potentially destabilizing. By discouraging explicit cooperation, antitrust policy encourages mood as a means of tacit coordination. On that count, antitrust policy must have been promoting merger waves, price fluctuations, and speculative bubbles.