FIN-01-031

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

October 9, 2001

Malcolm Baker, Jeremy C. Stein and Jeffrey Wurgler

ABSTRACT

We use a simple model of corporate investment to determine when investment will be sensitive to non-fundamental 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 two-and-a-half times as sensitive to stock prices as firms in the bottom quintile. We also verify several other predictions of the model.


Malcolm Baker
Institution: Harvard Business School
Email: mbaker@hbs.edu

Jeremy C. Stein
Institution: Harvard Economics Department and NBER
Email: jeremy_stein@harvard.edu

Jeffrey Wurgler
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Telephone: (212) 998-0367
Fax: (212) 995-4233
Email: jwurgler@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~jwurgler

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