Affiliated to

University of Mumbai

Revised Syllabus for

Programme:
Bachelor of Commerce
(Financial Marketing)
Semester V
Under Choice Based Credit System
Academic Year 2022-2023

PROJECT
ON
( Corporate Finance )
PROJECT REPORT
ON
TO ANALYSE THE CORPORATE FINANCE DECISION MAKING
UNSTABLE STOCK MARKET
SUBMITTED BY
ROLL NO: 41
DIVISION: B
NAME: DEVANSHI VORA
BACHELOR OF COMMERCE (FINANCIAL MARKETING)
(SEMESTER V)
UNDER THE GUIDANCE OF
SOURABH KOTWAL
ACADEMIC YEAR
2022 - 2023
TITLE PAGE NO
INTRODUCTION 1-3
OBJECTIVES 3
REVIEW OF LITERATURE 4-6
RESEARCH METHODOLODY 7- 8
DATA ANALYSE AND 9-12
INTERPRETATION
CONCLUSION AND SOLUTION 12-13
BIBLIOGRAPHY 14
TO ANALYSE THE CORPORATE FINANCE DICISION MAKING
UNSTABLE STOCK MARKET
INTRODUCTION
The stock market is seen as a reflection of what happens in the real world: A company releases
poor earnings results and its stock price tanks, or shares rise if the firm becomes an acquisition
target. But Wharton research shows that this is not the end of the road for the stock market’s
impact; how the stock reacts in turn affects a company’s decision-making in a sort of feedback
loop. And when corporate decisions are informed by the market, it leads to a higher market value
for the firm. Decision-making may be described as a deliberate process of selecting a specific
alternative from among the accessible options after conducting appropriate rational
evaluation. Within a certain environment, this cycle could be perceived as an association
between the issue that needs to be addressed and the entity that necessities to address it
(Narayan and Corcoran-Perry, 1997). Decision making is often complex, besides the
uniformity in decision making is almost impossible and requires a unique art to tackle these
complex situations. The reason being the influence of the diverse factors present in the
environment. Similarly, financial decision making is often characterized by high degree of
uncertainty as well as complexity, as an investor behaviour fluctuate from one to other in all
facets. In this manner an effective decision making in stock market takes under consideration
a stack of factors including personal factors, technical factors and situational factors and
requires an understanding of the human nature on top of financial skills. Moreover, empirical
confirmation from psychological studies reveal that people perceive each of their decision to
be novel and that an ideal investment choice for one investor may not fit another one, as their
investment objectives, and risk tolerance differ. Sanglier et al. (1994) illustrates that even if a
similar set of information is received by different investors, each investor will have distinct
interpretation of the same data. These differing interpretations will prompt differentiated
investor behaviours which will subsequently impact their decision making in financial
markets. Since investors decipher the acquired facts in their own way, every investor will
settle on another choice. In the broad arena of literature, research has proposed two
fundamental models of decision making. One is the rational model based on the norms of
homo economics and Expected Utility Theory (EUT). The other one is irrational model
guided by the Prospect Theory and Bounded Rationality assumptions. Rational decision
making theory asserts a structured and reasonable thought process, implying that an investor
has access to all sorts of statistics pertaining to that specific stock. Rational investor conducts
exhaustive searches and is unbound in terms of capacity and knowledge. Hence, taking
optimal rational decision is a very calculated phenomenon. This eminent rationality
hypothesis was long endorsed by the academic community in finance due to its prosperity,
effortlessness, and success to seize the stock price movements. Nonetheless, as the time
passed the assumption of rationality invited a severe criticism by a large academic
community. The critique has been levelled in terms of both the explanatory power of the
theory as well as the legitimacy of the underlying presumptions (Takahashi and Terano,
2003). Predominantly the empirical investigations carried out in 1980’s refuted the
assumptions of these rational models (Mahmood et al., 2011). These investigations
demonstrated that when people or organisations are accompanied with high degree of
uncertainty and complexity about choosing an alternative, they behave somewhat differently
from rationality, following a new concept of bounded rationality (Tseng, 2006). Thus, in
reality people display irrational behavior, as they have preference for some internal standards
as against some objective standards (Cummins and Nistico, 2002). These internal standards
may be inspired by their values, beliefs, emotions, feelings and intuition, that are all an
inherent part of human intellect (Haselton et al., 2005; Kahler, 2007; Keren and Teigen,
2004; Pullen, 2004). In behavioral finance terminology these are called psychological biases
or behavioral biases. Studies in economics and psychology have demonstrated that humans
are affected by numerous biases in the process of decision making, subsequently driving the
decisions to depart from the foremost ideal rational choices (Kahneman and Tversky, 1979).
These biases act as drivers and influence our cognitive thinking by making an individual
predisposed to behave in an irrational manner. Because of these mental predispositions the
decision making is not generally ideal, and the fact that behavioral inclinations without delay
affect the optimal choice making is overlooked by various investment experts and financial
professionals. In the realms of investments, such biases can have precarious effect and hence
understanding them is of significant importance (Byrne and Utkus, 2013).

For the sake of simplicity, this research paper is divided into different sections. Section one
describes in detail the rational approach to decision making. Second section discusses the
irrational and bounded rationality frameworks. Third section throws light on how people
actually handle their decisions and how people form their beliefs. Fourth section discusses
how people set up their preferences under the purview of Prospect Theory and its
applications. The fifth section analyses the role of emotions and its subsequent impact on
investment decision making, and, finally, the last section presents the discussion and
conclusion of the study. Decision-making is a complex process which includes analysis of
several factors and following various steps. It is believed that decision-making is based on
primarily two things: personal resources or factors, and technical factors. Similarly, while
making decisions in stock market, investors tend to rely on these two factors. Decision
making by individual investors is usually based on their personal factors such as age,
education, income, and investment portfolio, etc. Simultaneously, their investment decisions
are also derived from complex models of finance. These models include those based on
expected risk and return associated with an investment, and risk-based asset pricing models
like CAPM (Capital Asset Pricing Model). But decisions should never be made only by
relying on the personal resources and complex models, which do not consider the situational
factors. Situational factors are extended not only to the problem faced by the decision maker,
but also to the environment. So, in order to make appropriate decision, one needs to analyse
the variables of the problem by mediating them applying cognitive psychology. Decision
making can be defined as the process of choosing a particular alternative from a number of
alternatives. It is an activity that follows after proper evaluation of all the alternatives. Hence,
decision makers need to keep themselves up-to-date by obtaining information/knowledge
from diversified fields so that they can accomplish the tasks they have to work upon.
Effective decision-making in stock market requires better insight, and understanding of
human nature in a global perspective, apart from sharp financial skills and ability to gain best
out of investments. Positive vision, foresight, perseverance and drive are must for an investor
to be successful in his investment decisions. Investors differ in characteristics due to
demographic factors such as socio-economic background, educational level, age, gender, and
So, it is 4 difficult for an investor to make an appropriate investment decision on the basis of
the decisions made by someone else. It implies that an investment decision optimum for one
investor may not be suitable for the other investor. Every investor has his own investment
objectives, risk tolerance level, inflows and outflows of money, and other constraints. And
accordingly, he designs his investment portfolio considering all these factors. Institutional
investors have to estimate the output mean-variance optimization as well. But when it comes
to make investment decisions by individual investors, they fail to follow the standard
procedure for designing an optimum investment strategy.

OBJECTIVES
 To maximize the value of firm.
 Maximize the stockholder wealth.
 To the degree that they are correlated with the long term health and value of the company,
they work well.
 To the degree that they do not, the firm can end up with the disaster.
REVIEW OF LITERATURE
 (Mohammad al Mutairi, 2010) This study examines the relationship between
financing decisions such as capital structure, capital budgeting techniques and
dividend policy along with the firm’s attributes. We examined the impact of industrial
sectors and financial performance using the panel data of 80 listed companies in
Kuwait. The results of this study suggest that, contrary to the Trade-off Theory of
capital structure, there is a negative association between the level of debt and
financial performance. This can be attributed to the high cost of borrowing and the
underdeveloped nature of the debt market in Kuwait. Financing decisions such as
capital structure, capital budgeting techniques and dividend policy are considered to
be an important factor in an organization's ability to deal with its competitive
environment.

1
The Impact of Corporate Financing Decision on Corporate Performance in
the Absence of Taxes: Panel Data from Kuwait Stock Market

Mohammad Al Mutairi,
University of Wollongong - Australia
Associate Professor Helen Hasan
University of Wollongong - Australia
Assistant Professor Elizabeth Risik
Webster University – USA
II World Finance Conference- June 2011

Abstract
This study examines the relationship between financing decisions such as capital
structure,
capital budgeting techniques and dividend policy along with the firm’s attributes. We examined
the impact of industrial sectors and financial performance using the panel data of 80
listed
companies in Kuwait.

 (Mutairi, 2011) This thesis examines corporate financial decisions, corporate

governance and environmental concerns and their association with corporate
performance in emerging markets, such as those in the Arabian Gulf Region. Despite
the substantial published work on investigations into corporate finance decisions and
practices, corporate governance and corporate performance, none have
comprehensively studied the context of emerging markets. Indeed, most of the
empirical research on this topic has been conducted in developed markets such as the
USA and the UK. The research reported in this thesis addresses this significant gap in
the literature by comprehensively investigating corporate finance decisions, corporate
governance, environmental concerns and corporate performance in the context of
Kuwait, an emerging market in the Arabian Gulf Region.
 (Stewart C. Myers, 1983) This paper considers a firm that must issue common stock
to raise cash to undertake a valuable investment opportunity. Management is assumed
to know more about the firm's value than potential investors. Investors interpret the
firm's actions rationally. Consider a firm that has assets in place and also a valuable real
investment opportunity. However, it has to issue common shares to raise part or all of
the cash required to undertake the investment project. If it does not launch the project
promptly, the opportunity will evaporate. There are no taxes, transaction costs or other
capital market imperfections.

 (Damodaran) Germany and Japan developed a different mechanism for corporate

governance, based upon corporate cross holdings. • In Germany, the banks form the
core of this system. • In Japan, it is the keiretsus • Other Asian countries have modeled
their system after Japan, with family companies forming the core of the newcorporate
families n At their best, the most efficient firms in the group work at bringing the less
efficient firms up to par. They provide a corporate welfare system that makes for a more
stable corporate structure n at their worst, the least efficient and poorly run firms in the
group pull down the most efficient and best run firms down. The nature of the cross
holdings makes its very difficult for outsiders (including investors in these firms) to
figure out how well or badly the group is doing.

 (Muhammad Imran, 2020) Equity premium is a vital number in finance to be

considered for making fund allocation and investment decisions. One of the most
pressing, contemporary topics in advanced corporate finance and financial economics
is the equity premium and the magnitude of that equity premium in total returns. This
paper quantifies the impact of company fundamentals on the firm-level equity premium
in an emerging market, Pakistan, using a panel data technique for 306 nonfinancial
firms listed on the Pakistan Stock Exchange for the period January 2001 to December
2015. The company fundamental factors included profitability, liquidity, dividends,
solvency, efficiency, and size. Based on the literature, we selected proxies for
measuring company fundamentals of return on equity, quick ratio, dividend payout
ratio, debt-to-equity ratio, account receivable turnover ratio, and size, as company
fundamental variables as determinants of the equity premium. The company
fundamentals are the controllable factors for companies and can be revisited by
companies if they affect company returns.

 (K. Kirabaeva, 2013) Foreign direct investment (FDI) decisions—decisions related to

foreign entry and expansion by multinational corporations (MNCs)—are determined
by an evaluation of expected risks and returns in existing or potential host countries
(White and Fan, 2006). Risks range from political instability and policy uncertainty to
terrorist attacks and natural disasters (Perrow, 2011), which may negatively affect the
activities of companies in the short- and long-run. Natural disasters, in particular, are
directly and indirectly associated with substantial costs for businesses—for example,
damages to fixed assets and capital, damages to raw materials, and interruptions in the
production of goods and services (Cole, Elliott, Okubo, & Strobl, 2015). Unlike other
types of risks, natural disasters are more arduous to control. For these reasons, past or
present experience with disasters may deter a firm’s entry and expansion in a foreign
market (Oetzel & Oh, 2013), thereby reducing FDI.
RESEARCH METHODOLOGY
The Research Hypotheses and Empirical Model, A firm’s capital structure is measured by total
debt (short-term debt and long-term debt) to capital (debt plus equity). In this study, it has a
different financial system from the western countries, where banks tend to provide more short-
term than long-term debts. It has been argued that short-term debt presents negative effects on
a firm’s performance because of the risk refinancing a firm brings. Myers and Majluf (1984)
determined a negative relationship between performance and capital structure because firms
tend to depend on their internal funds for expansion to lessen approximate cost. Furthermore,
evidence from the emerging markets revealed a negative relationship between capital structure
and performance (Pandey, Chotigeat and Ranjit 2000; Pandey 2004).This suggests that the
capital structure has a negative influence on a firm’s performance. Thus,

hypotheses 1 and 2 are:

H1: A firm’s capital structure is expected to have a negative influence on its performance. H2:
A firm’s short-term debt decreases its performance.
The choice of dividend policy is defined using the dividend yield, which relates the dividend
paid to the price of the stock and is defined as the dollar dividend per share divided by the
current price per share. Listed firms in Kuwait seemed to follow one clear-cut hypothesis.
Kuwait has a unique tax environment where there is no personal or corporate tax on dividends.
Therefore, the tax preference hypothesis cannot hold true for this country since there is no tax
law that can be identified on dividend payments in Kuwait. In fact, the investors in this country
prefer companies that pay dividends to non-pay companies. Therefore, the bird-in-hand
hypothesis will hold true for Kuwaiti investors.
H3: A firm’s dividend policy has a positive effect on its performance. 8 A firm’s choice of
capital budgeting techniques is defined as the most frequently used techniques by respondent
firms (or a dummy that takes the value of 1 if the company is using at least 2 or more of capital
budgeting techniques and, the value 0 otherwise). Axelsson, Jakovicka and Kheddache (2002)
established the existence of a positive relationship between capital budgeting choices and firm
performance.
H4: A firm’s capital budgeting techniques is expected to have a positive influence on a firm’s
performance. A firm’s size is measured by the natural logarithm of total assets. The firm’s size
is hypothesized to be positively related to the firm’s performance. Wu (2006) found that a
firm’s size has a positive and significant effect on firm performance because a large size firm
is an indication of a firm’s market power or the level of concentrations in the industry. Having
such characteristics may enable the firms to generate greater returns on assets and sales, as well
as to capture more production value, leading to higher firm performance.
H5: A firm’s size is expected to have a positive influence on a firm’s performance. Risk is
measured by the standard deviation of earning divided by total asset used when accounting
performance measures are used, and, defined as beta when market performance is applied.
According to the classic risk return trade-off argument, firms with higher variability in
operating income are expected to have higher returns.
DATA ANALYSIS AND ITERPRETATION
The data used in this section was collected from various resources including the Reuters, Global
Investment House and Emerging Markets Information Service’s (EMIS) database. The data set
was comprised of all publicly traded firms listed at the KSE for the period from 2000-2008.
The selected sample for this study is based on the availability of the data for the period of
interest. All companies were required to issue their financial statements for every year between
2000 and 2008. The dataset contained detailed information about each firm. The dataset sample
included 80 listed firms in Kuwait. The sample gathered for the study had 14 sectors, including
both financial and non-financial companies. The information for all accounting related
variables were collected and calculated from annual financial reports, namely, the balance
sheets and the income statements, for each listed firm. All financial statements follow the
requirements of international standards. This research used the proxy (ROA) as an accounting
performance measure and (Tobin’s Q) as a market performance measure. Since it cannot be
established whether it is better to use accounting information or stock information in the
context of corporate finance decisions, we took into account both of these spheres. In addition,
using both accounting and stock 7 performance measures could shed light on the stock market
activity and aid in determining whether other factors affect corporate performance.

Source: COMPUSTAT data base and Center for Research in Security Prices (CRSP) data base,
at the Graduate School, University of Chicago. a. The sample for the annual analysis has 27,771
observations. b. Investment is defined as "capital expenditures" from annual statement of
changes in financial position, from COMPUSTAT, including COMPUSTAT Research File,
1959-87. c. Alpha is the lagged abnormal stock returns. CAPM betas were estimated for each
firm using all available monthly returns from CRSP, 1959-87. These betas were then used to
calculate an alpha for each year. d. Cash flow equals net income plus depreciation. e. New
share issue is the sale of common equity divided by the total market value of common equity
at the beginning of the year, from COMPUSTAT, 1971-87. Where the above data were
unavailable, including the years 1959-70, sale of common equity was estimated from the
change in the number of shares outstanding reported in CRSP, filtering out changes due to
liquidation, rights offering, stock splits, or stock dividends. f. New debt issues is the change in
book debt divided by the lagged value of book debt. g. The sample for the three-year analysis
has 7,950 observations.
These results show that outside financing roughly matches investment needs over a one-year
period, although firms also have their internal cash flows. It appears that firms issue much more
than they need for immediate investment. When we compute similar numbers over a threeyear
horizon, the number of firms that finance in excess of investment drops considerably. The
bottom panel of table 1 contains univariate statistics for our variables measured over
nonoverlapping three-year periods. Again, the high degree of volatility of investment is
confirmed. The standard deviation of investment growth is now 139 percent. Over an average
three-year period, investment rises by more than 77 percent for a quarter of all firm-period
observations. Roughly 20 percent of all firms expand their outstanding shares by 10 percent or
more over a three-year period.
A key question in our empirical analysis is over which horizon to estimate our growth rate
regressions. They can be estimated over relatively short time periods, such as single years, or
over relatively long time periods, such as three to four years. The problem with estimating over
one-year periods is that the regression would not capture delayed changes in investment due to
large changes in the firm's stock market valuation or in fundamental variables. As a practical
matter, the explanatory power of all variables is quite low when investment growth equations
are estimated annually. On the other hand, as the horizon gets longer endogeneity problems
become worse. One potential problem is the feedback from investment to sales discussed
above. Another is that we move closer to estimating an identity between sources and uses of
funds, though we are still very far from it. The right-hand side of our equation does not include
dividends, acquisitions, or accumulation of liquid assets. All things considered, we prefer the
three-year specification to the one-year specification.
Regression of the Stock Market's Influence on Investment The basic regressions for non over
lapping three-year periods are presented in table 2. In these regressions, we use
contemporaneous fundamentals, financing variables, and stock returns (represented by alpha)
lagged one year. That is, we measure investment growth from year t to year t + 3 and the stock
return from year t - 1 to year t + 2. All equations are estimated using a dummy variable for each
three-year time period. We have also estimated these regressions using industry period
dummies. The results are not qualitatively different, but the 30. In regressions run using annual
data, we found extremely low R2 's even in equations including both the stock returns and
fundamental variables. For this reason, we proceed to the three-year regressions.
Source: Authors' own calculations using COMPUSTAT and CRSP data bases with 7,950
observations from 1963- 87. See table 1 for an explanation of variables. The numbers in
parentheses are t-statistics.
Abnormal stock return does have noticeably lower incremental explanatory power. Omitting
the industry-period dummies leaves more room for relative stock returns across sectors to
predict differences in investment growth. Equation 2.1 confirms the basic starting point of this
paper-that stock returns predict investment. The parameter estimate suggests that a 10 percent
excess return on a firm's stock over three years predicts an average 5.3 percent increase in
annual investment by the end of the three years. The t-statistic is quite large, which is to be
expected with this many observations. The explanatory power of this regression is 15.7 percent
(13.1 percent without time-period dummies)-a respectable R2 for relative stock returns, but
less impressive considering that the stock return variable picks up the effect of any omitted
fundamental variables. Equation 2.2 shows that our two fundamental variables, sales growth
and cash flow growth, can explain 20.8 percent of the variation in investment over a three-year
period. Both variables are significant: a 10 percent growth in sales is associated with an 8.5
percent growth in investment over three years; a 10 percent growth in cash flow leads to a 1.8
percent growth in investment. Equation 2.3 represents one test of the hypothesis that the stock
market influences investment beyond its ability to predict future fundamentals, since the
equation includes contemporaneous fundamentals together with the lagged stock return. Not
surprisingly, the coefficient on alpha drops by about 40 percent from its level in equation 2.1.
When future fundamentals are held constant, the responsiveness of investment to lagged stock
returns is significantly smaller. The incremental R2 of equation 2.3 is only 3.8 percent relative
to that of equation 2.2. The lagged abnormal return explains only 3.8 percent of the variation
in investment beyond what can be explained by fundamentals. This incremental R2 is an
estimated upper bound on how much investor sentiment toward individual stocks can affect
investment.3' Presumably, if we could measure and include other fundamental determinants of
investment in the regression, the incrementalR2 would be even smaller.
Source: Authors' own calculations using COMPUSTAT and CRSP data bases with 2,042
observations every third year from 1963-87. See table I for a description of the variables. The
numbers in parentheses are t-statistics. a. A firm is classified as "small" if it falls in the bottom
quintile of all COMPUSTAT firms in terms of the market value of equity the first year it
entered the survey.
PUSTAT, it fell in the bottom quintile of all COMPUSTAT firms measured by the market
value of equity. This definition ensures that we do not make our classification based on in-
sample performance. Table 3 presents the results. Overall, "small" firms do not appear to be
very different from the rest of the sample. The stock market by itself explains 13.4 percent of
the variation in investment-less than in the whole sample. Fundamentals explain 17.7 percent
of the variation in investment, compared to 20.8 percent in the whole sample. This is not
surprising, since for smaller firms the more distant fundamentals are probably a more important
determinant of investment. The incremental R2 of the stock market, once fundamentals are
controlled for, is 2.2 percent, compared to 3.8 percent in the whole sample. There is no evidence
that the stock market is a more important predictor or determinant of investment for "small"
firms. The fundamental and financing variables together explain 19.6 percent of the variation
in investment. Interestingly, the coefficients on both the equity and debt financing dummies
are larger than they are in the whole 184 Brookings Papers on Economic Activity, 2:1990
sample, indicating the greater relative sensitivity of investment to external financing for "small"
firms. Financing variables add 2 percent to the R2, adding relative stock returns adds another
2 percent.
CONCLUSION AND SUGGESTIONS
This paper was motivated by the concern, present in both public policy discussions and in the
economics literature, that the stock market's deviant behavior has real consequences for the
economy. Is the stock market a sideshow, or does it instead direct investment, perhaps
erratically? We have tried to evaluate empirically whether the stock market has a large,
independent influence on investment using both firm-level and aggregate data. The firm-level
regressions show that movements in relative share prices are associated with fairly large and
statistically significant investment changes when fundamentals are held constant, but the
incremental R2 from relative stock returns is fairly small. The cross-sectional variability of
investment is sufficiently large that relative stock returns can account for only a small part of
it. We have argued that the explanatory power of relative stock returns for investment is
unlikely to be evidence that the stock market provides new information to managers, since
managers probably learn little from the market about their own firms' idiosyncratic prospects.
We have also provided evidence that the relation between relative stock returns and investment
is not driven by the costs of external financing. The explanatory power of relative stock returns
for investment may be evidence of the market exerting pressure on managers, although it also
seems likely that the market is picking up the effect of imperfectly measured fundamentals. By
simply including the contemporaneous growth rate in cash flow and sales we are able to reduce
the explanatory power of relative stock returns from 13 percent to 4 percent. In any event, the
4 percent incremental R2 from the return is small relative to what we expected. It suggests that
even if the market does exert pressure on managers (or even inform them), it is not a dominant
force in explaining why some firms invest and others do not. In some respects, the firm-level
evidence is much more important for policy discussions than the aggregate evidence. The
allocation of capital across firms and sectors strikes us as more important than the timing of
business cycles and the allocation of investment over time. The fact that, in the firmi-level data,
the stock market has small explanatory power for investment, beyond its ability to predict
fundamentals, suggests that complaints about the misallocation of resources due to the stock
market may be exaggerated. For if managers respond strongly to the market's whims about
their firms and that is a pervasive problem, we would expect these whims to explain a larger
part of the variation in investment. The market may not be a complete sideshow, but nor is it
very central. The aggregate evidence speaks to the issue of allocation of capital over time. High
stock prices can lead to high investment through low financing costs, and by signaling good
economic times, thus encouraging managers to invest. Such encouragement can be misleading,
as when sentiment leads corporate managers astray, or can be self-fulfilling, as when the market
acts as a sunspot. Our aggregate evidence rejects the importance of the financing effect of stock
prices for seasoned firms. There is no evidence that high returns lead to significantly more
equity or debt financing; in fact, debt financing is low following high stock returns. We have
also found substantial evidence against the view that the stock market acts as a faulty informant
about future activity. Controlling for fundamental and financing variables, the incremental R2
from stock returns is 2 to 3 percent, and the coefficients are borderline significant. Incidentally,
the fundamental variables that make the stock market redundant as a predictor go only as far
as one year ahead. The notion that the stock market evaluates long-term prospects of the
economy, and so guides long-term investment, is not supported by the data. Two views of the
stock market are consistent with the aggregate data. The first is the passive informant view,
which says that the stock market simply captures information that people already know, and
does not direct investment. The second view is that the stock market is the key sunspot,
coordinating the investment decisions of corporate managers, which are then justified by the
resulting boom or recession. Importantly, there is nothing irrational about the stock market in
this case, it just determines which of the possible multiple equilibria is at work. The first view
seems more appealing for several reasons. First, there is the Stock and Watson finding that the
stock market gets knocked out as a predictor of the short-run future course of the economy
once other predictors are included in regressions s. One could argue that the stock market is
the first sunspot and everything else follows, but this may be stretching it a bit. Second, in
episodes such as the late 1920s and post-October 1987 corporate managers have largely ignored
this sunspot. Overall, a fair reading of the evidence is that the stock market is a sometimes
faulty predictor of the future, which does not receive much attention and does not influence
aggregate investment. An important exception to this finding is the evidence from the initial
public offerings data, where both the stock market index and the discount on closed-end funds
help predict the pace of new offerings. This evidence, though limited by the lack of data,
suggests that in the market for new issues, the stock market and investor sentiment matter. It
could still be that market conditions affect only the timing of IPOs, and not their volume over
time. On the other hand, it could be that in low markets good ideas die because they cannot be
financed. The effect of investor sentiment on the new issues market is an important area for
further research.

Description of Data
In the appendix we describe the sources of our data and the methods used to calculate our
variables.
BIBLIOGRAPY

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Muhammad Imran, L. Z. (2020). An Empirical Analysis of Firm-Specific Factors and Equity Premium:
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