Working Paper: NBER ID: w8750
Authors: Malcolm Baker; Jeremy C. Stein; Jeffrey Wurgler
Abstract: We use a simple model of corporate investment to determine when investment will be sensitive to non-fundamental movements in stock prices. The key cross-sectional prediction of the model is that stock prices will have a stronger impact on the investment of firms that are 'equity dependent' - firms that need external equity to finance their marginal investments. Using an index of equity dependence based on the work of Kaplan and Zingales (1997), we find strong support for this prediction. In particular, firms that rank in the top quintile of the KZ index have investment that is almost three times as sensitive to stock prices as firms in the bottom quintile. We also verify several other predictions of the model.
Keywords: corporate investment; stock prices; equity dependence; KZ index
JEL Codes: E22; G31; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Equity-dependent firms (G32) | Investment sensitivity to stock prices (G11) |
| Equity-dependent firms (G32) | Investment sensitivity to Tobin's Q (G31) |
| Equity-dependent firms (G32) | Investment sensitivity to cash flow (G31) |
| Equity-dependent firms (G32) | Equity issuance responsiveness to stock prices (G12) |