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An in-Depth Understanding of Capital Market Theory: a Literature
Review in the Context of Financial Management
1

2

Novita Chyndi Pratiwi , Dinasty Ratu Ayu Dyah Pytaloka , Zainul Arifin

3

Departemen of Magister Manjamen, Institut Teknologi dan Bisnis Widya Gama Lumajang, Indonesia1,2,3
Corresponding Author: Novita Chyndi Pratiwi (novitachyndi48@gmail.com)

ARTICLE INFO

ABSTRACT

Date of entry:
27 April 2024

This article aims to present an in-depth understanding of capital
market theory and its relevance in the context of corporate
financial management. A literature review was conducted to
analyze various concepts, theories, and principles that underlie the
functioning of the capital market and their impact on financial
decision-making. By exploring the current literature, this article
provides comprehensive insights into capital market concepts,
including market efficiency, stock prices, portfolio diversification,
and investment strategies. In addition, this article also discusses
the role of the capital market in allocating financial resources,
increasing liquidity, and reducing risk for companies. As such,
this article provides a solid theoretical foundation for further
understanding of effective financial management.

Revision Date:
22 May 2024
Date Received:
28 May 2024

Keywords: Capital Market Theory, Financial Management
Cite this as: xxx

INTRODUCTION
The capital market is one of the important instruments in a company's financial management.
Capital market theory is the basis for understanding stock market behavior and how stock prices
can predict a company's performance. In this context, a literature review of capital market theory is
important to understand the concept and application of the theory in corporate financial
management.
Capital market theory is based on the premise that the stock market is efficient, that is, a market
that accurately and timely describes the information available. This theory emphasizes that stock
prices reflect the intrinsic value of a company, and that investors can profit by buying shares at a
low price and selling them at a high price.
In the context of financial management, capital market theory is important in investment decisionmaking. Investors can use the information available on the stock market to evaluate the company's
performance and predict the company's future earnings. One of the important measures in
evaluating the market's response to a company's earnings information is the Earnings Response
Coefficient (ERC)(R. W. D. Paramita & Hidayanti, 2013).

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In addition, agency theory is also the focus of this literature review. This theory emphasizes the
existence of a working relationship between the party who authorizes (principal), namely the
investor, and the party who receives the authority (agency), namely the manager, in the form of a
contract. Conflicts of interest between managers and owners can create agency problems, which
require additional costs called agency costs to address the problem.
In the context of the capital market, research on the influence of ERC on stock prices makes a
significant contribution to understanding stock market behavior and the importance of financial
information in investment decision-making. The implications of this study can help investors make
better investment decisions in the stock market, taking into account the market's response to the
company's earnings information.
Thus, a deep understanding of capital market theory becomes important in the context of corporate
financial management. This literature review provides a better understanding of the concept and
application of capital market theory in investment decision-making, as well as the importance of
financial information in predicting company performance.
LITERATURE REVIEW
History of the Capital Market
1. In the 17th century, the capital markets had existed and developed, especially with the advent
of the Amsterdam Stock Exchange in the Netherlands. The stock exchange was founded in
1602 by the Netherlands East India Company and is considered the world's first formal stock
exchange.
2. In the 18th century, industrial revolution in the United Kingdom played an important role in the
growth of the capital market with the emergence of companies that needed capital for
expansion.
3. In the 20th century, the capital market grew rapidly in the 20th century, especially after World
War II. Many countries have begun to form their own national stock exchanges and regulate
capital markets to ensure transparency and fairness in stock trading.
So it can be concluded that the capital market has experienced significant development from the
17th century to the 20th century. The emergence of the benchmark stock exchange in Amsterdam,
the Industrial Revolution and post-World War II capital market regulation are some of the
important milestones in the development of the capital market.
The Role of the Capital Market
The capital market plays a very important role in the economic development of a country. With an
efficient market mechanism, the capital market can be a driving force for economic growth by
allocating resources to the most productive sectors. Capital market efficiency allows companies to
obtain funds at lower costs, thus encouraging investment and business expansion. On the other
hand, investors can also obtain returns in accordance with the level of risk taken, thereby
increasing confidence and participation in the capital market.
Good capital market regulation is also a crucial factor in ensuring the integrity of the capital
market. Strict regulation and effective supervision are necessary to protect investors, prevent
illegal practices, and create a stable and sustainable market environment. With good regulation,
investors can feel safer and more confident to invest in the capital market, thereby increasing
market liquidity and overall economic growth. Capital market education and literacy also have an
equally important role. A good understanding of the capital market by the general public can
increase participation in the capital market, curate investment risks, and ensure that investment
decisions are made smarter. With high capital market literacy, people can take advantage of
existing investment opportunities and manage risks better.

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Thus, the capital market is not only a place for financial transactions, but also one of the main
pillars in the country's economic development. With good regulation, intensive capital market
education, efficient resource allocation, transparency and accountability, the capital market can
play a key role as a driver of sustainable and inclusive economic growth.
Implication
The capital market has various important implications for the economy of a country and its
stakeholders. Here are some of the significant capital market implications:
a. Fundraising: The capital market allows companies to raise funds from investors by issuing
stocks and bonds. This provides access to long-term funding sources that are essential for
business expansion, investment in major projects and innovation.
b. Resource Allocation: Through the capital market mechanism, economic resources are allocated
to the most productive and profitable sectors. Investors can choose to invest in a variety of
financial instruments according to their risks and investment goals.
c. Transparency and Fairness: An efficient capital market promotes transparency and fairness in
stock trading. Accurate and publicly available information allows investors to make more
informed investment decisions and minimize risk.
d. Increased Liquidity: With the capital market, investors have the ability to buy and sell stocks
with relative ease. This increases market liquidity and provides flexibility for investors to
change their investment portfolios.
e. Development of the Financial Industry: The growing capital market is also driving the growth
of the financial industry, including securities companies, investment management firms, and
other financial institutions. This creates new jobs and increases the contribution of the financial
sector to the economy.
f. Increased Economic Growth: A healthy and growing capital market can make a positive
contribution to a country's economic growth. Investments made through the capital market can
encourage the growth of high-potential economic sectors and create new jobs.
By understanding the implications of the capital market, governments and regulators can design
policies that support the healthy and sustainable development of the capital market, as well as
ensure that the benefits can be felt by all communities and the economy as a whole.
Benefit
The capital market has various benefits that are important for the economy of a country and its
stakeholders. Here are some of the key benefits of the capital market:
a. Long-Term Funding Sources: The capital market provides companies and governments with
access to long-term funding sources through stock and bond offerings. This allows entities to
obtain the necessary funds for business expansion, investment in large projects, and
infrastructure development.
b. Portfolio Divess: Investors can use the capital markets to diversify their investment portfolios.
By investing their investment portfolio. By investing in various financial instruments such as
sahm, bonds, and mutual funds, investors can reduce risk and increase the potential return on
investment.
c. Investment Liquidity: The capital market provides high liquidity for investors by allowing
them to buy and sell financial assets with ease. This allows investors to quickly convert their
investments into cash if needed
d. Transparency and Regulation: A well-regulated capital market promotes transparency in
corporate financial reporting and stock trading activities. Strict regulation helps protect
investors from fraudulent practices and market manipulation.
e. Increased Company Value: Through stock offerings, companies can increase the value of their
company and provide an opportunity for shareholders to share in the profits from the
company's growth.

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f. Economic Growth: A healthy and growing capital market can contribute positively to a
country's economic growth. Investments made through the capital market can encourage the
growth of high-potential economic sectors and create new jobs.
By understanding the benefits of the capital market, economic actors can harness the potential of
the capital market to support economic growth, create jobs, and improve the overall welfare of
society (Suhardini, 2015).

METHODS
The research method used in this article is the study of literacy. Literature study is a research
approach that is carried out by collecting, reviewing, and analyzing literature or publications
related to a certain research topic. In the context of this article, the author conducted a literature
review to analyze various concepts, theories, and principles that underlie the functioning of the
capital market and their impact on corporate financial decision-making (Widodo et al., 2023).

RESULTS AND DISCUSSION
This article aims to provide an in-depth understanding of capital market theory and its relevance in
corporate financial management. Through literature review, this article seeks to analyze the basic
concepts, theories and principles that are the foundation of the capital market and its impact on
financial decision-making. Capital markets have a key role in a company's financial management,
especially in investment decision-making. Capital market theory emphasizes market efficiency,
where stock prices reflect the intrinsic value of companies and investors can benefit from stock
price differences. This article discusses the conflict of interest between managers and company
owners explained by agency theory. The history of the capital market from the 17th to the 20th
century shows significant developments, including the emergence of the first stock exchange in
Amsterdam and the regulation of the capital market after World War II. This historical
understanding is important to understand the foundations and evoludi of the current capital market.
The capital market plays an important role in the economic development of a country with
efficient mechanisms, proper resource allocation, and a strong regulatory role. Capital market
literacy is the key to increasing participation and minimizing investment risks. The capital market
has significant implications for the economy, such as fundraising, resource allocation, increased
liquidity and economic growth. Good regulation and high capital market literacy are important to
ensure that the benefits of the capital market can be felt by the entire community. The article
mentions several benefits of the capital market, including long-term funding sources, portfolio
diversification, investment liquidity, increased company value, and economic growth.
Understanding these benefits is important to motivate participation and investment in the capital
market. This article provides a strong theoretical foundation and a deep understanding of the
capital markets and their relevance in corporate financial management. By outlining the concepts,
theories, and implications of the capital markets, this article can be a valuable source of knowledge
for readers interested in this field.

CONCLUSION
This article has provided an in-depth understanding of the capital markets and their relevance in
the context of corporate financial management. Through a literature review, the article explains the
basic concepts, theories, roles, implications, and benefits of the capital market in comprehensive
detail.

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The capital market plays a crucial role in a country's economic growth by allocating financial
resources efficiently, increasing liquidity, and reducing risks for companies. Capital market
theories, such as market efficiency, stock prices, and portfolio diversification, provide the
foundation for better investment decision-making.
In addition, this article also highlights the importance of good capital market regulation and capital
market literacy in ensuring transparency, fairness, and stability of the capital market. With a deep
understanding of capital markets, companies and other stakeholders can harness their potential to
support economic growth, create jobs, and improve the overall well-being of society.
As such, this article provides important insights for readers to understand the role and impact of
the capital market in the context of corporate financial management, as well as emphasizing the
importance of developing a healthy and inclusive capital market to achieve sustainable economic
growth.

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