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Does Firm-specific Information in Stock Prices Guide Capital Allocation?Art DurnevUniversity of Iowa - Henry B. Tippie College of Business Randall MorckUniversity of Alberta - Department of Finance and Statistical Analysis; National Bureau of Economic Research (NBER) Bernard Yin YeungNational University of Singapore - Business School April 15, 2001 EFA 2001 Barcelona Meetings; EFMA 2001 Lugano Meetings Abstract: We show that firms in industries in which firm-specific stock price variation is larger use more external financing and allocate capital with greater precision in the sense that their marginal q ratios are closer to one. Greater precision of stock prices in tracking firm fundamentals should alleviate the information asymmetry problem in outside financing and thus reduces its costs. Also, the greater precision should also improve monitoring and the precision in firm investment decision. Thus, our result is consistent with the view that greater firm-specific stock price variation indicates that stock prices are tracking fundamentals more closely, perhaps because of more intense interest on the part of risk arbitrageurs.
Number of Pages in PDF File: 67 Keywords: Capital allocation; Capital budgeting; Corporate investment policy; External financing; Firm-specific variation; Lemons problem; Stock market efficiency; Tobin's q JEL Classification: G1, G14, G3, G31 working papers seriesDate posted: January 11, 2001Suggested CitationContact Information
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