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Stock market and investment : the signaling role of the market

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  • Samuel, Cherian
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    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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    Bibliographic Info

    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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    1. Abel, Andrew B & Blanchard, Olivier J, 1986. "The Present Value of Profits and Cyclical Movements in Investment," Econometrica, Econometric Society, vol. 54(2), pages 249-73, March.
    2. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February.
    3. Schaller, Huntley, 1990. "A Re-examination of the Q Theory of Investment Using U.S. Firm Data," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 5(4), pages 309-25, Oct.-Dec..
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    8. Samuel, Cherian, 1996. "Stock market and investment : the governance role of the market," Policy Research Working Paper Series 1578, The World Bank.
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    19. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
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    22. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation for Research in Economics, Yale University.
    23. Marsh, Paul, 1982. " The Choice between Equity and Debt: An Empirical Study," Journal of Finance, American Finance Association, vol. 37(1), pages 121-44, March.
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    Cited by:
    1. Bolbol, Ali A. & Omran, Mohammad M., 2005. "Investment and the stock market: evidence from Arab firm-level panel data," Emerging Markets Review, Elsevier, vol. 6(1), pages 85-106, April.
    2. Mapa, Dennis S. & Briones, Kristine Joy S., 2006. "Measuring the Common Component of Stock Market Fluctuations in the Asia-Pacific Region," MPRA Paper 21247, University Library of Munich, Germany.

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