Question

Why is corporate investment sensitive to the market-to-book ratio? What does this sensitivity measure? Which firms (SOE vs. non-SOE) should have higher investment sensitivity to the market-to-book ratio and why?

Answer 1

Corporate investment are sensitive to market to book value because it is reflecting the valuation of the company in terms of its book value and there will be a comparison between the book value and the market value of various companies and it is often seen that companies are trading at Higher evaluation to the book values because various Assets of the company are recorded at historical cost in the books of accounts but they will be properly discounted in the market value as it reflects a consensus of large group of people.

This sensitivity is measuring the fluctuation of market value in respect to book value of the company and it is also reflecting the level of premium or discount which is offered by the market to the book value.

State owned enterprises have lower investment sensitivity to the market to book value because these state-owned enterprises are reflecting that there are not constantly changing their book value and they will not have a higher beta in the market in respect to the movement wheress non state owned enterprises are having more fluctuation in book value to market value because of change in the assets and liabilities held by these companies and it will also reflect that market participants are focused towards trading non-state entreprises so it will be having a higher sensitivity.