Increases In Capital Investments And Stock Returns
This study relates to test the relation between increases in capital investments and stock returns, and provides some explanation. Capital investment decisions are among the most important types of managerial decisions made in a firm. These investments can have major impact on the future returns of the firms return. The pioneer work of McConnell and Muscarella (1985) documented that the stock market, on average, responds positively (negatively) to firms' announcements of unexpected increases (decreases) in planned capital expenditures. This evidence suggests that the stock market, in general, rewards firms that undertake long-term capital investments.
There are a number of reasons why greater than before investment expenditures should be viewed favorably. First, higher investment expenditures are likely to be connected with greater investment opportunities. Second, higher investment expenditures may also indicate that the capital markets, which provide financing for the investments, have greater confidence in the firm and its management. Although firms tend to invest more following increases in their stock prices, cash flows tend to be the best predictor of a firm's investment expenditures (see, for example, Fazzari, Hubbard, and Peterson (1988) and Morck, Shleifer, and Vishny (1990).It is also the case that stock prices tend to respond positively to announcements of major capital investment. However, financing choices that are associated with increased investment, such as equity issuances, generally result in negative stock returns for example, Loughran and Ritter (1995) and others, while those choices associated with decreased investment, such as repurchases, generally result in positive returns Ikenberry, Lakonishok, and Vermaelen (1995) and others.
Such decisions involve a current resource outflow and a doubtful payback. Therefore, any significant corporate investment depresses current earnings and increases uncertainty about the firm's future performance. Capital investments involve the exchange of capital in the form of cash for less liquid assets such as equipment, land and working capital. Selection of good capital projects is important in hard work to add value to a company, to the cost-cutting measure and to society. The proper analysis of capital projects is essential. Capital projects are long-term – their life extends beyond the current period – and they support the creation of goods and services. Success at the “point of value” allows the company to make over capital in the form of goods and services back into cash.
Customers provide cash returns to the company in exchange for need accomplishment. Cash returns first cover operating costs, other expenses and various taxes. Net outstanding cash returns represent the net economic returns of and on capital. Capital investments are crucial to the future of a company. The appropriate economic analysis to support selection of investments is of great import in efforts to create value.
This understanding reveals that those firms increasing their investment in their assets gets the positive returns, while increasing investments in equity issuance get negative stock returns. Investment and stock returns are positively interrelated with each other when investment increases and stock prices raise stocks returns as well.
The undertaken learning examines the relationship between Capital Investments and Stock Returns from the background of a developing country such as Pakistan. The study looks at the issue from high capital investments perspective by focusing specifically on Pakistani Chemical sector. The main objective of this study is to discover out whether a number of factors as per existing literature pressure capital investments and stock returns of Pakistani Chemical sector.
This thesis now proceeds as follows:
Chapter 2 briefly reviews the existing literature.
Chapter 3 presents the variable constructions and their hypothesis
Chapter 4 presents the data and sample
Chapter 5 presents the empirical analysis of data and obtained results.
Chapter 6 presented finally the conclusion of the thesis.
The roots of the literature of capital investments relate to Tobin (1969) and von Furstenberg (1977) examined that corporate investments and stock market are positively correlated. The traditional justification for this relationship was that stock prices reflect the marginal product of capital.
2.1 Strategic investments and stock valuation
According to traditional valuation theory, the market value of the firm is the sum of (a) the discounted value of future cash flows expected to be generated from assets in place and (b) the net present value of expected cash flows from investment opportunities that are expected to be available to and undertaken by the firm in the future (Brealey and Myers, 1988). The value of a firm changes as the stock market receives general or firm-specific information that changes the market's expectations about the cash returns from current and future assets.
Recent financial theory argued that managers were compelled by capital market forces to make investment decisions aimed at maximizing firm value (Fama and Jensen, 1985; Rappaport, 1986; Reimann, 1987). According to this view, accounting-based performance measured such as earnings per share, return on investment, and return on equity did not properly measure the value of managers' investment decisions. The true test of the long-run value of an investment decision was whether it created economic value for shareholders as measured by abnormal stock returns (Rappaport, 1986). Therefore, the Share-holder Value Maximization hypothesis predicted that the stock market will react positively to corporate announcements of strategic investment decisions. Such decisions increase a firm's market value by enhancing its ability to generate future cash flows.
2.2 Relevancy of Present Value Theory
The reason for holding risky investments (as distinct from holding cash) was to receive an income or profit. Alternative objectives might possibly be stated: (1) to maximize the rate of return of capital over a time period by the assumption of some specified maxi-mum acceptable level of uncertainty, (2) to obtain some specified target rate of return with the assumption of a minimum level of uncertainty, or (3) to maximize the investor's present wealth by holding securities possessing an optimal combination of future returns and amounts of uncertainty. The underlying notion regarding these stated objectives was that individual securities tend had a positive correlation between the size of the rate of return expected and the level of uncertainty surrounding the expected return. The motives of investors in investing were to obtain returns and to restrict size of uncertainties related to such returns. Consequently, the estimated monetary value placed on an investment by investors was determined by the expected size of future cash payments and the estimated investment quality (degree of investment uncertainty) associated with such future payments.
The work of the Carnegie School (e.g., Cyert & March, 1963) made an early contribution and laid the groundwork for successive research that studied investment decisions. These studies specially examining the process of capital investment decision making provide the reference point for the field study reported here. Beginning with Bower's (1970) well-known study, this work has developed expressive models of the capital investment process based on analyses of real capital project proposals, typically in large multidivisional firms.
Shiller (1981) had documented that should one expect a tight relation between investment and the stock market? It is helpful to start with a simple standard case. Consider a firm with a profit function that is linear in capital, and where the manager and asset market participant had access to the same information. Assume that asset markets value the firm at its fundamental value. It was founded that it is well-known the manger and the markets will effect go through the same assessment exercise in assessing investment projects.
Atiase (1985), (1987) Collins and Kothari 1989; Easton and Zmijewski (1989) studied on the earnings response coefficient (ERC) had shown that factors such as size, risk, and growth are important to the valuation of the firm's earnings. Since earnings are reflections of the firm's investments, it seemed natural to expect that the valuation of the underlying investments was also sensitive to these and other relevant factors. Few studies, however, had tested whether this was true.
It had been examined the value relevance of changes in firms' capital expenditures. A traditional view was that capital expenditures provide information to the market about a firm's future earnings that was not captured by current earnings, as managers responded to private information about future demand and costs through their investment decisions. This approach assumed that the relevant cross-sectional differences lied in factors that affect only the valuation of a particular subgroup of securities. It had been shown, for example, that firms which had a higher (lower) change in capital expenditures than their industry provided a positive (negative) valuation signal for example Lev and Thiagarajan (1993).
To emphasize the value significance of individual firm factors, we incorporated variables which mediate the effect of the firm's risk, growth, and earnings levels on the capital expenditures response coefficient (CRC). Initially, when we do not control for size-related difference, the CRC is slightly significant only in the existence of the mediate variables. This suggested that unexpected capital expenditures provide a value significant signal for firms containing certain distinctiveness. However, when we controlled for size-related differences in pre discovery information (i.e., by adjusting the lead-lag structure of returns according to the size of the firm), the capital expenditures responded coefficient became much larger and statistically significant. In addition, the mediate variables become statistically significant with the expected signs.
The original work of McConnell and Muscarella (1985) documented that the stock market, on average, responded positively (negatively) to firms' announcements of unanticipated increases (decreases) in planned capital expenditures. This evidence suggested that the stock market, in general, rewarded firms that undertake long-term capital investments.
Jensen (1986) examined that there are also reason investment expenditures may result in negative stock returns. For example, managers have to give the impression of being at the best possible opportunity to increase their capital in order to give good reason for their expenditures. This result is mostly important for those mangers that are empire builders, and invest for their own remuneration rather than the benefits of shareholders.
Barwise, Marsh, and Wensley (1987) pointed out that more or less everything about a firm-its physical assets, and how they are used. To understand a capital investment decision, it is important to understand how the physical asset in which a firm is investing will interact with existing assets, tangible ones, such as equipment.
Chan et.el (1990), however, found that high-technology firms that announced increases in research and development spending experience positive abnormal returns, on average, whereas announcements by low-technology firms were associated with negative abnormal returns. This evidence suggested that the market was able to distinguish between good and poor investment prospects and, on average, only rewards firms that made good investments.
A possible explanation was that the market reaction depended upon both the type of investment decision and other information conveyed by the investment announcement. To investigate this possibility, we examined the stock market responded to firms' announcements of business relocation decisions.
This research work studied business relocation decisions for two reasons. Primary, these decisions included the relocations of corporate headquarters, supplementary headquarters or unit offices, and plants. Given the mixed evidence regarding the market's response to plant closing/facilities consolidation and corporate headquarters relocation decisions, a sample of business relocation announcements allowed an examination of whether the type of investment or facility (such as a headquarters or a plant) affected the market's valuation of a firm's investment decision. Next, a firm's relocation decision can result in either an expansion of the firm's business or production level (by relocating to a new market area or to a new facility), or a decreased in the firm's facilities or production capacity (by relocating and consolidating existing facilities). So far, the empirical evidence indicated that, on average, the market responds positively to the establishment of new projects or increases in capital expenditures (such as investments in property, plant, and equipment, or in research and development), but negatively to discontinuations or consolidations of existing facilities that lead to a reduction in firms' facilities or production capacity (such as plant closing or facilities consolidation decisions).
The market, on average, reacted positively to relocation decisions that were motivated by business expansion or cost savings, but negatively to decisions that were motivated by capacity reduction or facilities consolidation. This result indicated that the market interprets investment decisions as signals of the future prospects of a firm.
The evidence reconciled several results in the literature concerning the stock market response to announcements of investment decisions. This paper analyzed the stock market response to 447 announcements of firms' decisions to relocate their corporate headquarters, subsidiary or unit headquarters, and plants. Similar to previous studies, this research work found that the stock market reacted negatively to plant relocation announcements but positively to headquarters-relocation announcements. A more detailed analysis, however, found that the differing market reactions to headquarters and plant relocations were caused by the differing motives underlying these decisions and the implied prospects for the firm.
Cochrane (1991) incorporated a time-to-plan between investment decisions and investment expenditures, also corrected for the sequential aggregation of investment data. The resulting model fits well with US industry-level investment data and industry portfolio equity returns over the 1951-2001 periods. The central concept was the investment return, firms those transfer resources through time by making small portion of variation from the most favorable capital investment expenditures that at the end of the day maximizes the value of the firm’s equity and in return the companies increase their stock returns.
Cochrane (1991) examined that stock returns and investment expenditures are positively correlated, because when the discount rate falls the companies be supposed to increase their capital expenditures. Those firms increase their investment expenditures when the discount rate fall at so because of this their stocks returns are negative in the opening years, but in future the stock returns increase. Performance of investment expansion in those years when discount rates falls, the stock returns also generate with the expenditures at those years.
It has been experimented that when the discount rates move up the investments go down. Investment plans have considerable forecasting power for annual stock returns, and contain information not capture by other forecasting variables. Observe investment policy is essential to establish that predictable investment and predictable returns are negatively associated. Without observing investment plans, one might incorrectly conclude that unpredicted investment is negatively correlated with unpredicted returns.
Fama (1991) pointed out that any correlation experimental between fundamental variables and returns could be consistent with market inefficiencies, or with the fundamental variables omitted risk factors. The combined hypothesis environment of the problem prevents an unambiguous declaration of whether the expectedness of returns, either over time or cross section-ally, was a result of market inefficiency or not. However, documenting such predictability, for whatever reason, may still be useful. For example, it may lead to a better understanding of the behavior of security prices, and in making financial investment decisions. In addition, evidence from the Japanese market helped to shed further light on whether one fundamental variable (e.g., earnings yield) subsumes another (e.g., size), and on whether the results are robust to time period and sample composition.
This research work found that the cash flow yield variable and the book to market variable had the expected positive signs. It was examined important relationship between fundamental variables and expected returns in the Japanese market. Of the four variables considered, the book to market ratio and cash flow yield had a reliably positive impact on expected returns. The performance of the size variable, although in general consistent with previous findings, turns out to be highly dependent on the specific model and time period. While previous studies documented a strong positive earnings yield effect, we found no such evidence after controlling for the other variables. These conclusions were based on a variety of substitute statistical condition.
Robins (1992) argued that the capital investment in a material asset in terms of the capabilities linked with that asset raises the issue generating the return to the investment. It is the physical asset, and it is the firm-specific way in which the asset is used. The return to capital investment has two major components which are (1) the market-determined return to the asset, which might be realized by any firm employing that asset, and (2) supplementary rents earned by the firm-specific way in which the asset is employed-that is, the gap capability that the firm has developed.
(Baldwin & Clark, 1992) examined that while investing the firm should classify and understand its physical assets and then make decision of capital investment, and provide insight into how companies use capital investment as a instrument for developing operating-level organizational capabilities and stock returns.
Fazzari, Hubbard, and Peterson (1988) and Morck Shleifer, and Vishny (1990) found that there is a significant literature which examined corporate capital expenditures. For example, even though firms tend to invest more following increases in their stock prices, cash flows have a tendency to be the best predictor of a firm's investment expenditures.
FAMA AND FRENCH (1992) found that two variables, market equity (ME) and the ratio of book equity to market equity (BE/ME) capture much of the cross-section of average stock returns. If stocks were priced rationally, systematic differences in average returns were due to differences in risk. Thus, with rational pricing, size (ME, stock price times shares outstanding) and BE/ME must proxy for sensitivity to common risk factors in returns.
French (1993) confirmed that portfolios constructed to mimic risk factors related to size and BE/ME add considerably to the variation in stock returns explained by a market portfolio. Moreover, a three-factor asset-pricing model that included a market factor and risk factors related to size and BE/ME seemed to capture the cross-section of average returns on U.S. stocks.
We document size and book-to-market factors in earnings like those in returns. The earnings of firms in different size-BE/ME groups loaded on market, size, and BE/ME factors in earnings in much the same way that their stock returns load on the market, size, and BE/ME factors in returns. The fact that the common factors in returns mirror common factors in earnings suggested that the market, size, and book-to-market factors in earnings were the source of the corresponding factors in returns. The tracks of the market and size factors in earnings are clear in returns.
Loughran and Ritter (1995) examined the association between the capital investment and stock returns. The stock prices are more expected concerned with the major capital investment. Financing choices that are associated with the increase in investment through increase equity of the corporate, normally result in a harmful stock returns. On the other hand those companies investing repurchases rather than equity, normally result in a positive stock returns.
There are more than a few other possible reasons that why the increased investments should be viewed satisfactorily. Those companies have higher investment expenditures are associated with the higher investment opportunity, and other reason is that higher investment expenditure also may point toward capital market and puts a confidence in the management and a firm as well. Above study provide evidence and our own evidence also indicates that stock prices increase in those years when the companies increase their capital expenditures.
Louis K. C et.el (1991) examined the cross-sectional relationship between financial variables and stock returns had attracted a considerable amount of research attention in the U.S. In contrast, there was limited evidence for the Japanese market. In order to fill this void, this paper related cross-sectional differences in returns on Japanese stocks to the underlying behavior of four fundamental variables: earnings yield, size, book to market ratio, and cash yield.
The findings of research revealed a significant cross-sectional relationship between the fundamental variables we considered and expected returns in the Japanese market. The performance of the book to market ratio was especially noteworthy; this variable was statistically and economically the most important of the four variables investigated. If earnings yield was considered in separation or included with size, it indeed had a positive and significant impact on returns. Overall, of the four variables, the book to market ratio and cash flow yield had the most significant impact on expected returns.
The market, in general, reacted positively to replacement decisions that were motivated by business expansion and cost savings. This evidence was consistent with McConnell and Muscarella's (1985) founded that the market reacted positively to the unanticipated increases in a firm's long-term investment. The market, in general, responded unhelpfully to relocation decisions associated with "capacity reduction" or "facilities consolidation" motive that lead to a reduction in a firm's facilities or production capacity. This evidence was consistent with Blackwell, Marr, and Spivey's (1990) found that the market responded negatively to a plant closing announcement. Blackwell, Marr and Spivey argued that the negative market response might be caused either by the negative information conveyed in the announcement regarding the future profitability of the firm, or by the market's belief that managers were making poor abandonment decisions. Our finding provided strong support for their first argument.
Strategic investment decisions were major commitment of current resources made in anticipation of generating future payoffs. By definition, such decisions involved a current resource outflow and an uncertain payback. Therefore, any significant corporate investment miserable current earnings and increased uncertainty about the firm's future performance.
Only three empirical studies had investigated the relationship between strategic investment announcements and stock prices. One study examined the relationship between joint-venture formation and announcement-day stock prices (McConnell and Nantell, 1985). It treated joint ventures as one type of capital expenditure, a special form of inter corporate 'merger,' in which only a subset of the resources of two (or more) firms are joined together to accomplish some strategic objective. The sample was 210 firms involved in 136 joint ventures during 1972-79. Joint-venture formation was positively and significantly correlated with announcement-day returns. This finding was consistent with the Shareholder Value Maximization hypothesis.
One more study analyzed the relationship between research and development (R&D) projects and stock prices (Jarrell, Lehn, and Marr, 1985). The sample was 62 R&D announcements made in the Wall Street Journal during 1973-83. The primary hypothesis was that a negative stock price reaction to R&D expenditure announcements would support the 'short-term argument' or the Institutional Investors hypothesis. Research and development announcements were found to be significantly associated with positive stock returns. These findings challenge the 'short-term argument' about the stock market. The third study examined the reaction of stock prices to 658 announcements of increases or decreases in the dollar amount of planned capital expenditures (McConnell and Muscarella, 1985). Announcements of increases (decreases) in capital budgets were significantly associated with positive (negative) abnormal stock returns for industrial firms but not for public utilities. The taken as a whole conclusion was that, for industrial firms, the stock market's reaction was consistent with the Shareholder Value Maximization hypothesis.
The findings had several implications for strategic management research and practice. They indicated a very clear and strong relationship between strategic investment decision announcements and stock market valuation. In some cases the stock market reacted negatively to a firm's investment announcement. The market may had lacked confidence in that firm's strategy or future prospects, management's ability to implement the investment project successfully, or the timing of the proposed investment.
This study supported the existence of a strong relationship between financial factors and investment decisions, which contradicted the basic irrelevancy proposition established by Modigliani and Miller (1958). This suggested that firms (even large well-established ones) operated in imperfect markets, which left researchers and policy makers to deal with the critical issues of how and why these imperfections affect firm investment decisions, and evidence was provided within this context.
3.1. Dependent Variable
3.1.1 (Capital Investments)
In this study dependent variable capital investment as fixed assets and it is taken from the State Bank balance sheet analysis and the annual reports of the companies.
This evidence is potentially related to the De Bondt and Thaler (1985) return reversal evidence as well as to the Loughran and Ritter (1995) evidence that firms that increase investment expenditures are likely to have enjoyed positive stock return
Fazzari et.el(1988) and Morck et.el(1990) examined the corporate capital expenditures. Firms tend to invest more following increases in their stock prices; cash flows tend to be the best predictor of a firm's investment expenditure. It was also examined that stock prices tend to respond favorably to announcements of major capital investments.
Ikenberry, Lakon-ishok, and Vermaelen (1995) also determined that financing choices that are associated with increased investments with equity issuances result in negative stock returns but the choices that are related with repurchases by capital investments generally result in positive returns.
Thus in our study capital investment is taken as fixed assets of the companies.
3.2. Independent variables
As per available literature following independent variables have been identified that affect by the capital investment decisions of the firms. Below are the independent variables along with their hypothesis
3.2.1. Market Equity
The Market Equity is an explanatory variable as per literature; it has been taken from Karachi Stock Exchange website. It has positive and significant relationship with capital investments of the firms according to literature. Banz and Breen 1986, Fama and French 1992, 1993 conducted a study on capital investments and shown that market equity is an important factor. Banz and Breen 1986 a firm's market equity (ME) is defined as its price multiplied by the number of shares outstanding. This research work highlights the fact that though Market equity has a positive relationship with Capital Investments. According to the Banz and Breen 1986, Fama and French 1992, 1993 conducted a study on capital investments and shown that market equity is an important factor.
H: There is a positive relationship between capital investments and market equity.
The explanatory variable size has been taken in the study to check the impact size of the firms on the Chemical sector of Karachi Stock Exchange (KSE) on the capital investments and it is calculated as Log of total assets. It has positive and significant relationship with capital investments of the firms according to literature. Banz and Breen 1986, Fama and French 1992, 1993 conducted a study on capital investments and shown that size is an important factor. Banz and Breen 1986 a firm's size is defined as its log of total assets.
H: There is a positive relationship between capital investment and size.
3.2.3. Book-to-market Equity ratio:
Book-to-market equity ratio an explanatory variable as per literature, it has been taken calculated from the balance sheet of the companies. It has positive and significant relationship with capital investments of the firms according to literature. Banz and Breen 1986, Fama and French 1992, 1993 conducted a study on capital investments and shown that book-to-market equity is an important factor. Banz and Breen 1986 the book-to-market equity ratio (BM) is computed as the ratio of the book equity (BE).
Book value divided by equity. Fama and French (1992) indicated that the book-market ratio (B/M) has the strongest relation with expected stock returns in the United States.
H: There is a positive relationship between capital investment and book-to-market equity ratio.
Table 1: Variables and Relationship with Capital Investments
Relationship with Capital Investments
Book-to-market equity ratio
4.1. Data and Sample
This study is carried on the Chemical sector of Pakistan. There are 35 firms of that sector which are listed on the Karachi Stock Exchange. But after screening the firms with incomplete data, we have selected 26 firms having complete data for six years from 2003-2008 as our study covers the period from 2003-2008. So we have 156 firm years for the data analysis.
This study is conducted on Secondary data and collected six years data from 2003 to 2008 of 26 KSE listed company in Chemical sector for research work. The 26 Chemical companies are given below:
Following sources for data collection which is mentioned below:
Company’s website for collect their financial statements for financial data which will be used in this research work
Karachi Stock Exchange
Karachi stock exchange web site and personal visit for collect the information about market price of shares of their listed companies in chemical sector.
The Period under the study is 2003-2008. Data collected from company’s website about their market prices of shares.
The statistical techniques of correlation and regression were used to explore the relationship between these variables.
EMPERICAL ANALYSIS OF DATA
For the analysis of pooled data for six years i.e. 2003 to 2008 correlation matrix was constructed and the technique of multiple linear regression analysis was used. An attempt was made to develop a multiple regression equation using identified key variables. The Capital Investment(y) was used as dependent variable and other variables X1, X2 and X3 were used as independent variables. On this basis under mentioned multiple linear regression equation was developed.
C.I= β0 + β1 (ME) + β2 (SZ) + β3 (BM Equity) + ε.
C.I= Capital Investment
ME= Market Equity
BM Equity = Book-to-market equity ratio
ε= Error term
Where, is the regression constant β1, β2, and β3 are regression coefficients respectively.
The regression coefficient indicates the amount of change in the value of dependent variable for a unit change in independent variable. The coefficient of determination, gives an estimate of the proportion of variance of dependent variable accounted for by the independent variable. It suggests the covariance between changes in Capital Investments and stock returns. The value of varies between 0 and 1. An of zero means that the predictor accounts for none of the variability of (Y) by (X). An of 1 means perfect prediction of y by x and that 100% of variability of (Y) is accounted for by (X). The higher the value of , the closer the relationship between variables.
5.1. Correlation Matrix
The correlation matrix shows the relationship or association between the dependent variable and explanatory variables (Table 1). The results of correlation matrix are as follows:
Table 2: Correlation Matrix
**. Correlation is significant at the 0.01 level (2-tailed).
The value of Pearson Correlation is 0.671 which indicates positive and strong relationship between Capital Investments and Market Equity with significance of .000 which is less than 0.05 means impact of capital investments have also positive impact on market equity. Capital Investments and Size shows the relationship which is highly correlated and Pearson correlation of 0.752 which indicates positive and strong relationship between Capital Investments and Size with significance of .000 which is less than 0.05. The value of Pearson Correlation is -.426 which indicates weak and inverse relationship between Capital Investments and Book-to-Market Equity Ratio with significance of .000 which is less than 0.05.
An early study was conducted as well by Tobin (1969) and von Furstenberg (1977) examined that corporate investments and stock market are positively correlated.
5.2. Regression Results
Table 2: Regression Results of Empirical Model
Table 3 ANOVA Analysis
Sum of Squares
a. Predictors: (Constant), BMEquity, ME, SZ
b. Dependent Variable: C.I
The above ANOVA table tests the acceptability of the model from a statistical perspective. The Regression row displays information about the variation accounted for by the model while the Residual row displays information about the variation that is not accounted for by the model. As the Residual sum of squares (3.095E9) is less than Regression sum of squares (5.233E9), which indicates that high variation in Capital Investments is explained by the model. It is also evident from the significance value of the F statistic which is less than 0.05.
While the ANOVA table is a useful test of the model's ability to explain any variation in the dependent variable, it does not directly address the strength of that relationship.
So in order to check strength of the relationship between the model and the dependent variable we have another table of Model Summary which is as follows.
Table 4 Model Summary
Adjusted R Square
Std. Error of the Estimate
Predictors: (Constant), BMEquity, ME, SZ
Dependent variable: Capital Investments
The above model summary table reports the strength of the relationship between the model and the dependent variable Capital Investments in our study. The value of R (the multiple correlation coefficients) is 0.793 or 79.3 % which indicates strong and positive relationship. The value of R Square (the coefficient of determination) shows that about 62.8% variation in Capital Investments is explained by the model. Our model becomes significant in the Pakistan’s Chemical sector sector’s environment. This study reveals that those firms increasing their investment in their assets gets the positive returns. An earlier study conducted by Loughran and Ritter (1995) regarding the capital investments and stock returns. Stock prices tend to respond favorably to announcements of major capital investment. Moreover, another study conducted by Tobin (1969) and von Furstenberg (1977) examined that corporate investments and stock market are positively correlated. Fazzari et.el (1988) and Morck et.el (1990) Loughran and Ritter (1995) examine the association between the capital investment and stock returns. The stock prices are more likely concerned with the major capital investment.
Table 5 Regression coefficient
The regression results confirmed results which were obtained from correlation matrix. The results found that Market Equity, Size and Book-to-market ratio have significant regression coefficient at 1 % level of significance respectively. Also, the same variable has significant correlation with Y as is evident from correlation matrix.
This section of regression analysis is further divided into subsections which interprets the results of all independent variables one by one.
5.2.1. Market Equity
The regression results indicate positive and significant relationship between Market Equity and Capital Investments with significance level less than 0.05 or 5%. This result highlights the fact that though Market equity has a positive relationship with Capital Investments. According to the Banz and Breen 1986, Fama and French 1992, 1993 conducted a study on capital investments and shown that market equity is an important factor. Because in Chemical Sector the level of investment is high so as investment increases the market prices increases as well. So our hypothesis is accepted here that there is a positive and significant relationship with Market Equity.
The results indicates that the size an explanatory variable for the Chemical sector of Pakistan because regression coefficient is statistically significant. According to Banz and Breen 1986, Fama and French 1992, 1993 conducted a study on capital investments and shown that size is an important factor. Our result in Chemical Sector of Pakistan also found that there is positive and significant between Size and Capital Investments. So our hypothesis is accepted here that there is a positive and significant relationship with Market Equity.
5.2.3. Book-to-market equity ratio
The results of the study show positive and significant association between Book-to-market equity and Capital Investments. According to Fama and French (1992) indicated that the book-market ratio (B/M) has the strongest relation with expected stock returns in the United States. Evidence is emerging on relations between stock returns and fundamental variables in international markets. Chan et.el (1991, 1993) showed that expected stock returns in Japan are positively related to B/M equity ratio. Thus, in Chemical sector of Pakistan it also found that there is also positive and significant relationship of Book-to-market equity and Capital Investments. Therefore we accepted our hypothesis here that there is a positive and significant relationship between Book-to-market equity and Capital Investments.
In this paper we examined the relationship between Capital Investments and three explanatory variables for firms which are in chemical sector of Pakistan. The explanatory variables are market equity, size and book-to-market equity ratio. In this study we analyzed a sample of 27 firms of Chemical sector which are listed on the Karachi Stock Exchange and having complete data for six years from 2003-2008. So we analyzed 156 firm years’ data to test hypotheses that there is significant positive relationship between Capital Investments and Stock Returns. Our model becomes significant in the Pakistan’s Chemical sector’s environment.
The results showed that there is positive relationship between capital investments and three explanatory variables (market equity, size and book-to-market equity ratio) and our results were significant to accept our hypothesis. So we accepted our hypotheses. Hypothesis had proved relevant in chemical sector.
Since past studies on capital investments and stock returns De Bondt and Thaler (1985) return reversal evidence as well as to the Loughran and Ritter (1995) evidence that firms that increase investment expenditures are likely to have enjoyed positive stock return. This paper contributes by extending the literature by taking data from Chemical sector of Pakistan.
Some interesting results were obtained that had important implications for Pakistani investing persons that the results are the significant and positive relationship between Capital investments. Indeed, the higher the investment in the firm the higher is the profits so higher the stock returns as well. It shown that when chemical firm invest in more capital expenditures for more production and plants finally the greater profits, therefore the Chemical sector of Pakistan given stock returns when they invest more in the firm. These results were confirmed by Fazzari, Hubbard, and Peterson (1988) and Morck, Shleifer, and Vishny (1990) examined the corporate capital expenditures. Firms tend to invest more following increases in their stock prices; cash flows tend to be the best predictor of a firm's investment expenditure. Ikenberry, Lakon-ishok, and Vermaelen (1995) also determined that financing choices that are associated with increased investments with repurchases by capital investments generally result in positive returns.
This research is useful for the person who will invest in chemical sector of Pakistan by the knowing that which company invests more in their assets and in other area of investing, so they will have good stock returns at the end of period. So basically this research paper is beneficial for the investor who invests in share market for the purpose of the both capital gain and stock returns.
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