Do Managers Listen to the Market? A Review of the Relationship between Investment and Stock Price Informativeness

Abstract

Using a sample of stocks from developed and emerging markets, we analyze the sensitivity of investment to stock price. Consistent with prior research, we find a positive association between investment and stock prices (measured by Tobin’s Q), although more pronounced in developed markets than in emerging markets. Remarkably, that association increases with the informativeness of stock prices. However, not all measures of informativeness relate positively with investment-stock price sensitivity. While measures related with the amount of private information conveyed by prices (e.g., price non-synchronicity) heighten the investment-stock price sensitivity, others, such as the variance ratio or delay in the assimilation of common-wide information, hardly affect that sensitivity. To gauge the presence of a causal relationship between price informativeness and investment-stock price sensitivity, we explore a quasi-random event that enhances the information environment of a stock: reconstitutions of MSCI ACWI. By means of an instrumental variables approach, we show that positive (exogenous) shocks on the price informativeness of stocks elevate the investment-stock price sensitivity. Overall, these results support theories of managerial learning, i.e., managers extract information from stock price when making investment decisions, in particular when prices convey more private information not known to them.

Keywords: Investment, Stock Prices, Price Informativeness, Managerial Learning, Real Effects of Financial Markets

JEL Classification: G14, G30, G31