Equity Market Fragmentation and Capital Investment Efficiency

Abstract

This study examines how equity market fragmentation affects firms’ capital investment decisions. Recent empirical research finds that market fragmentation lowers trading costs and thus improves market quality. We examine whether this increase in market quality translates into greater revelatory price efficiency, where stock prices reveal with greater precision information to managers and/or creditors about firms’ investment opportunities. Consistent with this notion, our findings reveal that the association between capital investment and investment opportunities is increasing in market fragmentation. Additional evidence suggests that (a) market fragmentation increases revelatory price efficiency at least in part by encouraging information acquisition and informed trade by equity investors and (b) the more efficient stock prices inform both managers and creditors about firms’ investment opportunities. Inferences based on difference-in-differences and instrumental variable tests are consistent with those based on our primary findings. This paper was accepted by Suraj Srinivasan, accounting. Funding: The authors are grateful to the Kenan-Flagler Business School, Cox School of Business, Smeal School of Business, and David Eccles School of Business for funding our research. Supplemental Material: The data files and online appendix are available at https://doi.org/10.1287/mnsc.2023.4905 .