Legal Protection, Equity Dependence and Corporate Investment: Evidence from Around the World

In this paper, we investigate the effects of legal protection of investors and the equity-financing channel on the relationship between corporate investment and stock prices in an international setting. We find that firms in countries with stronger legal protection of investors have investments that are more sensitive to their stock prices. In addition, equity-dependent firms display a higher investment-to-price sensitivity than do nonequity-dependent firms, which is consistent with the equity-financing channel argument. Finally, the positive relation between legal protection and the investment-to-price sensitivity is more pronounced for equity-dependent firms than for nonequity-dependent firms. Overall, our evidence complements the earlier finding by Baker et al. (2003) and suggests that both legal protection of investors and the equity-financing channel influence managers' corporate investment decisions with respect to changes in stock prices.