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.