Kauppakorkeakoulu | Rahoituksen laitos | Rahoitus | 2015
Tutkielman numero: 14269
The effect of overvalued equity on financing decisions - European evidence
|Otsikko:||The effect of overvalued equity on financing decisions - European evidence|
|Vuosi:||2015 Kieli: eng|
|Asiasanat:||rahoitus; financing; päätöksenteko; decision making; arviointi; evaluation; markkinat; markets|
|Avainsanat:||financing decisions; equity issuance; overvalued equity; misvaluation; market timing; inefficient markets|
PURPOSE OF THE STUDY The purpose of this thesis is to study whether and how equity overvaluation affects corporate financing decisions. The inefficient market approach to corporate finance predicts that firms will raise more capital, and especially issue more equity, when their shares are overvalued. Misvaluation affects the firm because it reduces the extent to which equity issuances and repurchases cause dilution and concentration of long-term shareholders' shares. By issuing more, the firm generates a profit for its existing shareholders, which, ceteris paribus, increases the long-term stock price. This is desirable both for existing shareholders, and for a manager who wishes to increase long-term stock price. In my study, I use a forward looking misvaluation measure that filters scale and growth prospects from market price. When studying why overvaluation affects financing decisions, I test how sensitivity of issuance to misvaluation varies across valuation, size, book-to-market, and R&D.
DATA My sample includes firms located in Western Europe, Norway and Switzerland. The sample firms' financial data come from Thomson Datastream, and earnings forecast data from Institutional Brokers' Estimate System (I/B/E/S). My final sample consists of 15,095 firm -year observations between 1994 and 2012.
RESULTS The evidence presented in this study supports the proposition that overvalued equity is important for firms' financing decisions. The thesis provide evidence that overvaluation induces firms to raise cheap capital, especially equity. However, I do not find support that it is only among overvalued stocks that equity misvaluation positively affects new issues. In addition, the thesis provide further evidence that firms, which have high growth opportunities have higher sensitivities of equity issuance and total financing to misvaluation as measured either by low book-to-market ratios or by high levels of R&D expenditures. This is somewhat consistent with managers catering and investment scale economies effects.
Opposite to the size hypothesis, I find that large firms have higher sensitivities of equity issuance and total financing to misvaluation. Owing that small firms have less access to equity markets, it can potentially limit their ability to fund investments with overvalued equity. I do not find support for the hypothesis that sensitivity of new issues to misvaluation is higher among high-turnover firms. In fact, my results show that the sensitivity is greatest among "normal" turnover firms, indicating that investor's short-term horizon does not guide managers' issuance decisions.
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