When Does the Market Matter? Stock Prices and the Investment of Equity-Dependent Firms

TLDR: This paper used a simple model to outline the conditions under which corporate investment will be sensitive to non-fundamental al movements in stock prices and found that 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.

Abstract: We use a simple model to outline the conditions under which corporate investment will be sensitive to non-fundament al 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.