Mispricing, Corporate Investment and Stock Returns: Evidence from Pakistani Stock Market

Abstract

The present study empirically investigates the impact of stock mispricing (i.e., overvaluation or undervaluation of stocks) on corporate investment decision of firms. Mispricing in stocks is measured by discretionary accruals while corporate investment is measured by change in fixed tangible assets. A sample of 386 non financial firms listed on Karachi stock exchange during the period 1998-2011 is analyzed in the study. Fixed effect model is employed for estimation purposes. Congruent with existing literature, the results reveal that discretionary accrual has positive and significant effect on the corporate investment. Furthermore, the impact of the higher investment is investigated on future stock returns of the firm and it is observed that the resultant higher investment ultimately leads to lower subsequent stock returns. The study therefore, concludes that mispricing of stock returns will result in higher investments which would have its adverse effects on their future stock prices.

Stock mispricing and investment decisions: evidence from Pakistan

“…Their focus has been on the overvalued firms only and they did not identify the effect of undervalued firm. Like other studies, for instance, Gilchrist et al (2005) and Baker et al (2003); Haque and Naeem (2016) could only manage to find the impact of the one-sided, overvaluation, effect of mispricing on investment.…”

“…This is an indication that equity issuance and accrual are done by the overvalued firm (Polk and Sapienza, 2002, Chang et al , 2007), but they fail to identify that if the high accruals show the overvaluation then the low accruals do not mean the undervaluation, and it shows only one side of mispricing. Like other studies, for example, Gilchrist et al (2005) and Baker et al (2003), Haque and Naeem (2016) could only manage to find the impact of the one-sided effect of mispricing, overvaluation, on investment.…”

“…Haque and Naeem (2016) found the effect of this mispricing on corporate investments by using discretionary accruals to measure the mispricing because these are usually followed by negative future return. This is an indication that equity issuance and accrual are done by the overvalued firm (Polk and Sapienza, 2002, Chang et al , 2007), but they fail to identify that if the high accruals show the overvaluation then the low accruals do not mean the undervaluation, and it shows only one side of mispricing.…”

“…There are some studies available on mispricing in the context of Pakistan like Haque and Naeem (2016); Javaria and Hassan (2015) and Qureshi et al (2012). But this study is different from these studies.…”

“…Haque and Naeem (2016) found the impact of stock mispricing on corporate investment. They measured stock mispricing by using discretionary accruals.…”