MARKET SKEPTICISM: SHORT INTEREST RATIO AND ITS EFFECTS ON FINANCIAL CONSTRAINTS

Abstract

This paper delves into the long-debated question of stock market rationality, exploring the relationship between stock prices and corporate investment within the frameworks of classical and behavioral views. The classical perspective posits that markets are efficient, where stock prices reflect fundamental changes in expected cashflows or discount rates, suggesting no direct link between stock prices and corporate investment. Conversely, the behavioral view contends that managers time their equity issuances to capitalize on overvalued stock prices. Baker, Stein, and Wurgler's (2003) model challenges the classical view, accounting for noise traders and their impact on stock prices. Stein (1996) argues that investor sentiment, driven by stock price overestimation, influences investment decisions. The paper assesses the effect of equity mis-valuation on corporate investment, considering both efficient and inefficient market theories, which suggest that higher stock prices should correlate with increased corporate investment. Overall, this study sheds light on the intricate interplay between stock market rationality and corporate investment decisions.