ARTICLE | ANNUAL REVIEW OF FINANCIAL ECONOMICS

Capital Market-Driven Corporate Finance

by Malcolm Baker

Abstract

Much of empirical corporate finance focuses on sources of the demand for various forms of capital, not the supply. Recently, this has changed. Supply effects of equity and credit markets can arise from a combination of three ingredients: investor tastes, limited intermediation, and corporate opportunism. Investor tastes, when combined with imperfectly competitive intermediaries, lead prices and interest rates to deviate from fundamental values. Opportunistic firms respond by issuing securities with high prices and investing the proceeds. A link between capital market prices and corporate finance can, in principle, come from either supply or demand. This framework helps to organize empirical approaches that more precisely identify and quantify supply effects through variation in one of these three ingredients. Taken as a whole, the evidence shows that shifting equity and credit market conditions play an important role in dictating corporate finance and investment.

Keywords: Venture Capital; Cost of Capital; Values and Beliefs; Resource Allocation; Supply Chain; Investment;Price; Markets; Capital Markets; Interest Rates; Equity; Corporate Finance; Financial Services Industry