Cross-Market Timing in Security Issuance

Abstract

The conventional view of market timing suggests an unambiguous, negative relation between equity misvaluation and the equity share in new issues - that is, firms with overvalued equity issue more equity and, all else equal, less debt. We question this conventional view in the paper. Using price pressure resulting from mutual funds' flow-induced trading to identify equity misvaluation, we first show that equity and debt prices are affected by the same shocks, but to different degrees. Next, we document substantial cross-sectional variation in the sensitivity of issuance decisions to equity misvaluation. In particular, firms with sufficient internal resources increase equity issues and yet decrease debt issues in our measure of equity misvaluation; in contrast, firms that are heavily dependent on external finance increase both equity and debt issues, to take advantage of the misvaluation in both. In sum, this paper provides evidence that equity and debt can be jointly (mis)priced, and more important, examines the resulting impact on firms' issuance decisions.