Stock Market Valuation and Firms’ Investment in the Presence of Market Frictions: Evidence from Saudi Arabia Adnan F. Abo Al Haija* Abstract This paper aims at examining the relationship that might exist between stock market valuation and corporate investment in a small emerging resource-based economy like Saudi Arabia. The existence of such a relationship is supported in theory as well as in the empirical evidence of previous studies. Tobin’s q reflects firms’ growth opportunities. It is considered by many researchers as the major, if not the sole, factor determining corporate investment in the absence of market frictions. Misvaluation in the stock market is one of the market frictions found to have a significant effect on firm’s investment. Managers attempt to expand their investment plans when the stock prices of their firms move towards overvaluation. This occurs most likely when investors are expecting, either correctly or erroneously, a good performance of those firms in the product, and consequently in the stock markets. Financing constraints is also another factor affecting firms’ investment, which represents an important friction in the capital market. Firms facing constraints in getting external finance will switch towards internally generated funds to finance their investment plans. This paper examines the firms’ investment determinants in the presence of market frictions by using data from Saudi Arabia. The sample of the study includes 120 companies, which comprises all the exchange-listed companies in all sectors except financial, banking, insurance, and utilities sectors. The time frame of data covers the period 2010 to 2014. The empirical results confirm our theoretical predictions regarding the solid link between corporate investment and the stock market. It is found that stock market significantly affects firms’ investment through two different paths: Tobin’s q and stock market valuation. If markets revalue the growth opportunities of firms (higher Tobins’ q), or overvalue their stocks, higher investment expenditures will result. On the other hand, Saudi companies are found not to be financially constrained. JEL Classification: D21, G14, M21 Keywords: Corporate investment, market frictions, Tobin’s q, misvaluation, Saudi Arabia.