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Stock market and investment : the signaling role of the market

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Author Info
Samuel, Cherian
Abstract

The author examines the role of the stock market as a signal to managers in undertaking capital expenditures. He concludes that while both managerial and market perceptions are integral, managerial perception is of greater importance. The evidence suggeststhat, as a statistic, the Q ratio is not sufficient to explain firms'capital expenditure decisions. Thus, the standard Q model of investment should be modified to provide a more meaningful description of a firm's capital spending decisions. Overall, the results suggest that stock market activity has only limited implications for the economy's resource allocation process. Evidence for the Q theory of investment confirms previous findings in the literature that the model's poor empirical perfomance was partly the result of using aggregate data for the whole economy. Also, since market perception plays only a limited role in determining capital expenditures, shareholder myopia is unlikely to result in managerial myopia. The implications for developing countries are: while the stock market may not be central to a firm's capital spending decisions, it is not a sideshow either. The market plays an important signaling role for managers. This is a powerful rationale for financial reform and capital development in developing countries. The results also suggest that complaints that stock market activity leads to misallocation of resources may be exaggerated.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1612.

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Date of creation: 31 May 1996
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Handle: RePEc:wbk:wbrwps:1612

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Keywords: Economic Theory&Research; International Terrorism&Counterterrorism; Markets and Market Access; Payment Systems&Infrastructure; Fiscal&Monetary Policy; Markets and Market Access; Environmental Economics&Policies; International Terrorism&Counterterrorism; Economic Theory&Research; Access to Markets;

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  18. Nabi, Ijaz, 1989. "Investment in Segmented Capital Markets," The Quarterly Journal of Economics, MIT Press, vol. 104(3), pages 453-62, August. [Downloadable!] (restricted)
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    Other versions:
  21. Taggart, Robert A, Jr, 1977. "A Model of Corporate Financing Decisions," Journal of Finance, American Finance Association, vol. 32(5), pages 1467-84, December. [Downloadable!] (restricted)
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