Stock mispricing and investment decisions: evidence from Pakistan

Abstract

Purpose This study aims to examine the impact of stock mispricing on corporate investment decisions by taking the sample of non-financial firms listed on the Pakistan Stock Exchange during the period of 2008-2014. Design/methodology/approach To measure the mispricing, this study decomposes the market-to-book ratio into mispricing and growth components and measures corporate investment by capital expenditures. Fixed and random effect panel regression models are used to estimate the results. Findings Results of the study show that firms issue overvalued equity to finance the capital expenditures. Consistent with other studies, the relationship between stock mispricing and investment is more prominent in the financially constrained firms. In addition, cash flow investment sensitivity is higher in financially unconstrained firms. Practical implications Nonetheless, the results give important implications to the Pakistan Stock Market on how the mispricing enhances the welfare by relaxing the financial constraints and allowing the managers to make investment in profitable projects that otherwise go non-funded. These findings have interesting implications for further research in the literature of finance and also help in economic policy-making. Originality/value This study finds the impact of stock mispricing on corporate investment decisions by considering the role of market timing in the context of Pakistan.