Fundamentals of Corporate Finance

Fundamentals of Corporate Finance

Fundamentals of Corporate Finance

Importance of Market Prices to a Finance Manager

A connection between capital market charges and business finance can in standard arrive from either provide or demand. This framework assists to coordinate empirical approaches that more precisely recognize and quantify supply consequences through variation in one of these three ingredients. Taken as a entire, the evidence displays that moving equity and borrowing market situation play an important role in dictating business investment and investment.

The empirical facts of asset pricing have gotten in the way of such a crisp delineation between supply and demand effects in corporate finance. The supply of capital is not elastic at a price that reflects fundamental value. There are three kinds of studies that disclose this. The first asks whether market prices respond to investor demand for securities (or a supply of capital) that is unrelated to fundamentals. In fact, they do. The second asks whether securities with the same fundamentals trade at the same price. In some instances they do not. The third asks whether security returns are predictable in ways that are unrelated to risk, suggesting that investor tastes or expectations shift over time and move price away from fundamental value. In principle, they are, whereas the minutia is still debated. The short summary is that the supply of capital is at least somewhat inelastic and that varying investor tastes dictate the location of an upward-sloping supply curve.

Answer 2

The first approach is to test for a positive correlation between market prices and corporate decisions. For equity market effects, valuation ratios and past returns are common proxies for market pricing. For borrowing markets, interest rates and interest rate spreads are often used. The critical idea is that part of a valuation ratio, such as the ratio of the market value of assets to its book value contains the reduced form impact of investor tastes. If book value serves as a rough measure of fundamentals, a high market-to-book is consistent with positive sentiment. Prior research does suggest that market-to-book includes a component that is unrelated to longer run value.

For some sets of corporate decisions, this is a reasonable approach for understanding supply effects. For example, with dividend policy, the valuation ratio of interest is the difference between the market-to-book ratios of dividend payers and non-payers. There is no traditional, demand-driven theory that predicts a relationship between the relative valuation of ...