Equity Market Fragmentation and Capital Investment Efficiency

This study examines how equity market fragmentation affects firms’ capital investment decisions. Recent empirical research finds that market fragmentation improves market quality. We examine whether this increase in market quality translates into greater revelatory price efficiency, where prices reveal with greater precision information to managers and/or creditors about firms’ investment opportunities. Findings reveal that the association between capital investment and investment opportunities is increasing in market fragmentation. Additional findings reveal that (a) the effects of market fragmentation on capital investment increase with financing constraints and (b) market fragmentation is associated with a higher sensitivity of new loans to investment opportunities, suggesting that the effects of market fragmentation work primarily by reducing information asymmetry between creditors and borrowing firms. We find evidence that market fragmentation also provides information to managers about the firm’s investment opportunities; the effects of market fragmentation on capital investment decrease with the extent to which managers are informed. Inferences based on difference-in-differences and an instrumental variable test are consistent with those based on our primary findings.