Managerial market timing under credit risk: How do timed buybacks and stock issuances influence the value of long-term shareholders?

Abstract

Using discounted cash flow valuation together with a Merton-style credit risk model this paper quantifies the effects of credit risk on timed equity buybacks and issuances. Assumed managers act in best interest of their long-term shareholders and do have superior information, the potential value gain for long-term shareholders out of market timing with and without credit risk is evaluated. As demonstrated in a real-world example, credit risk is important. Ignoring credit risk results in value gains of buybacks motivated by smaller (larger) mispricing levels being underestimated (overestimated), while value gains of issuances driven by lower (larger) mispricings are overestimated (underestimated). These effects are stronger for firms with higher debt levels.