Where Does the Market Matter? The Real Effects of Financial Development and Investor ProtectionΨ

We study how market values and cash flow affect investment and external finance in a sample of firms drawn from 44 countries over an 18-year period. We find that the relations between market values and both investment and external finance are stronger in countries with higher levels of financial development and investor protection. We further show that in these countries investment-sensitivity to cash flow is lower, and low cash flow firms are more likely to issue shares and debt to finance their investment. These findings are broadly consistent with the notions that financial development and investor protection encourage accurate share prices, access to external finance, and efficient investment. Consistent with these interpretations, we find that investment more strongly predicts higher sales growth in developed financial markets