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Stock market and investment : the signaling role of the market

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  • 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.

Suggested Citation

  • Samuel, Cherian, 1996. "Stock market and investment : the signaling role of the market," Policy Research Working Paper Series 1612, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1612
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Cherian Samuel, 2000. "Does shareholder myopia lead to managerial myopia? A first look," Applied Financial Economics, Taylor & Francis Journals, vol. 10(5), pages 493-505.
    2. Cherian Samuel, 1998. "The investment decision: a re-examination of competing theories using panel data," Applied Economics, Taylor & Francis Journals, vol. 30(1), pages 95-104.
    3. 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.
    4. 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.
    5. Cherian Samuel, 2001. "Stock market and investment: the signalling role of the market," Applied Economics, Taylor & Francis Journals, vol. 33(10), pages 1243-1252.

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