Stock Markets, Investment, and the Real Economy: An Analysis of Firm-Level Data in India

Using a large panel of Indian firms, we investigate if mispricing in the stock market has an impact on firm-level investment. A significantly positive relation is observed between investment and the proxies for mispricing in the listed manufacturing firms, suggesting that overpriced (underpriced) firms tend to overinvest (underinvest). Moreover, we observe that equity-dependent firms display a more pronounced sensitivity of investment to stock misvaluation than do non-equity-dependent firms. Therefore, our findings imply that mispricing in Indian stock markets may have a significant influence on the real economy and the influence works through an equity-financing channel. However, investment is not sensitive to stock mispricing when we consider all listed firms and listed non-manufacturing firms.