Which Firms Follow the Market? An Analysis of Corporate Investment Decisions

Abstract

Do firms extract information from their own stock prices when making investment decisions? To answer this question, we use and extend an econometric errors-in-variables remedy, which is appropriate because movements in the stock price in which the manager takes little interest can be treated econometrically as measurement error. We find that firm investment does not respond to measures of stock-market mispricing. Investment does respond to legitimate information in price movements, but only for firms that rely on outside equity financing and whose shares are not mispriced. Interestingly, these firms' behavior changed only little during the late 1990s.