Does Firm-Specific Information in Stock Prices Guide Capital Allocation?
67 Pages Posted: 11 Jan 2001
Date Written: April 15, 2001
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.
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
Suggested Citation: Suggested Citation