The Feedback Effect Of Security Price On Firms’ Investment

Whether financial market could affect firms’ behavior and the real economy is one of the most important topics in the field of financial economics.It has become a consensus that frictions in primary financial markets will eventually reduce real economic activities,but whether the secondary financial market can also affect firms’ behavior and the real economy remains controversial.Classical economic models believe that security prices in the secondary financial market is "passive",which means it only reflects future cash flows of a firm but cannot in turn affect cash flows.However,it seems to contradict the widespread attention gained and large amount of resource input in the secondary financial market in the real world.In the past three decades,academia has focused on discussing the possibility that secondary financial markets directly affect the real economy and proposed that prices can influence,as well as reflect,cash flows.In this view,although the secondary market will not lead to any direct transfer of resources to firms,the prices can change the behavior of decision makers by sending meaningful signals,thus having an impact on firms’ decision-making and the real economy.The ideas that decision makers learn new information from secondary market prices and use this information to guide their decisions can be traced back to Hayek(1945).Financial markets are where many speculators with different information gather to trade,trying to profit from their information.Aggregating these different pieces of information,security prices ultimately reflect an accurate assessment of the value of the company,thus managers can learn from prices and use it to make the optimal decision.As a result,the feedback effect of price information enables the secondary financial market to have a real impact on the real economy.Based on the viewpoint that prices in secondary market display a feedback effect of information,the existing literature constructs various theoretical models to explain some "anomalies" in traditional financial theory.At the same time,the informational role of prices has also been applied to the areas of corporate governance and corporate finance.Among which,the relationship between price information and firms’investment has been widely concerned.However,most of the literature focuses on discussing the informational role of stock market prices and ignores the influence of other secondary markets,like bond market.Moreover,most of the existing empirical results are based on developed economies and mature capital markets,lacking evidence from emerging markets.This paper studies the feedback effect of secondary market price on firms’investment in the context of China.Specifically,it studies whether managers learn from firms’own stock prices,peers’stock prices and bond prices,and use them to guide the investment decisions.The main conclusions are as follows:First,this paper takes the implementation of the Shanghai-Hong Kong Stock Connect Scheme at the end of 2014 as an opportunity to study the relationship between stock price of a firm and its investment efficiency.I find that after the establishment of the scheme,the informativeness of stock price increased due to the increase of foreign investors,thus improving firms’ investment efficiency.This effect is more pronounced in firms that there are more funds from Hongkong stock market flowing into,that not cross listed in A and H share markets and that do not have QFII shareholders before the launch of the scheme.Second,this paper studies the influence of peers’ stock prices on R&D investment.I find that high price of peers’ stock has significantly reduced firm’s R&D expenditure.It is more pronounced when the fields of firms’ R&D activities are quite different from the ones of peers.I examined the effect of volume and value of information on the relationship between peers’ stock prices and firms’ R&D expenditure.For the volume issue,the results show that the information of peers’(firms’)stock prices strengthens(weakens)the effect of peers’ stock prices on firms’ investments.Regarding the value issue,I document a stronger effect when the market competitions are more severe and when the market shares of firms are less.Third,taking the break of rigid payment in China’s bond market as an opportunity,this paper studies the impact of bond financing on firms’ R&D expenditure.I find that after the breaking event,the bond prices have clearly diverged since the yield to maturity of high-rated bond issuers has continued to decrease,while that of low-rated companies has increased.The results show that both low-rated and high-rated firms cut R&D expenditure but with different motivations.The low-rated firms reduced the investment as a response to expected increasing financing cost,while the high-rated firms were pursuing spread margin by shifting funds from R&D activities to investments in trade credit and financial assets.Compared with the existing literature,the main contributions of this paper are:First,this paper supplements the literature on the information role of security price with empirical evidences from emerging market countries.While most of the existing empirical evidences are based on developed economies and mature capital markets,the conclusions may be limited in generality and extensibility when it comes to emerging markets,where the market efficiency and liquidity,the investor structure and stock market size are quite different from those of developed economies.Based on the China’s context,this paper conducts empirical tests using critical events in the process of financial market reform and opening,which not only provides appropriate exogenous shock scenarios for the verification of existing theories,but also provides evidence for the idea that secondary market prices play an information role in emerging markets.Second,from the perspective of bond market,our research enriches and expands the literature on the influence of financial market price on firms’ investment.Most of the existing papers in this field have focused on whether the prices of secondary stock market are informative,how they affect the merger decision and investment efficiency of firms,but ignored that other secondary financial markets(such as the bond market)may also have an impact on the firms’ behavior.Our results show that in the bond market,which is another important secondary market,security prices can also play an information role,affecting firm decision-making and even the real economy.Third,this paper provide evidence to strengthen the market-oriented reform of the financial system and expand opening up in China.In the past decades,China’s financial market reform and opening had been relatively slow.But since the 18th National Congress of the Chinese Communist Party,policymakers have gradually accelerated the deepening the reform and opening up of the financial market.In recent years,regulators have broken the rigid payment of the trust industry,banking industry,bond market and online lending one by one,as well as established the connection between Shanghai and Shenzhen stock exchanges and Hong Kong stock exchange.The conclusions of this paper can not only help to evaluate the impact of the policy to deepen financial market reform and opening up,but also provide important referred path in implementing the reform plan to make financing industry work in serving the real economy.