Market Timing and Market Timing and Capital StructureCapital Structure

PresenterPresenter ： 張鳯逸　 ： 張鳯逸　 909603909603

　　　　　邱麗卿　 　　　　　邱麗卿　 919608 919608

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Motivation 1:Motivation 1: The exist of “equity market timing”.The exist of “equity market timing”.

Firms tend to issue equity when market value is Firms tend to issue equity when market value is high, relative to book value and past market values, high, relative to book value and past market values, and repurchase equity when market value is low.and repurchase equity when market value is low.

The findings are difficult to reconcile with the The findings are difficult to reconcile with the MM’s capital structure irreverent theory.MM’s capital structure irreverent theory.

In inefficient or segmented capital markets, In inefficient or segmented capital markets, market timing benefits ongoing shareholders at market timing benefits ongoing shareholders at the expense of entering and exiting ones. the expense of entering and exiting ones. Managers thus have incentives to time the market.Managers thus have incentives to time the market.

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Motivation 2:Motivation 2: Many corporate financing decisions depend on equity Many corporate financing decisions depend on equity

market timing.market timing. There is evidence in four different kinds of studies.There is evidence in four different kinds of studies.

studiesstudies findingsfindingsfinancing financing decisionsdecisions

firms tend to issue equity instead of debt when firms tend to issue equity instead of debt when market value is high and tend to repurchase market value is high and tend to repurchase equity when market value is lowequity when market value is low

long-run stock long-run stock returnsreturns

equity market timing is successful on averageequity market timing is successful on average

earnings earnings forecastsforecasts

firms tend to issue equity at times when firms tend to issue equity at times when investors are rather too enthusiastic about investors are rather too enthusiastic about earnings prospectsearnings prospects

market timing market timing surveyssurveys

managers admit to market timingmanagers admit to market timing

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Purpose and conclusion 1:Purpose and conclusion 1: We would like to know how equity market We would like to know how equity market

timing affects capital structure.timing affects capital structure. The basic question is whether market timing has a The basic question is whether market timing has a

short-run or a long-run impact. short-run or a long-run impact. One expects at least a mechanical, short-run One expects at least a mechanical, short-run

impact.impact. If firms subsequently rebalance away the influence If firms subsequently rebalance away the influence

of market timing financing decisions, then market of market timing financing decisions, then market timing would have no persistent impact on capital timing would have no persistent impact on capital structure.structure.

The conclusion is that market timing has large, The conclusion is that market timing has large, persistent effects on capital structure.persistent effects on capital structure.

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Purpose and conclusion 2:Purpose and conclusion 2: The results are explained with some theory of capital structure.The results are explained with some theory of capital structure.

TheoryTheory ViewsViews ResultResult

Trade-off Trade-off theorytheory

Market-to-book is an indicator of investmentMarket-to-book is an indicator of investment

opportunities, risk, agency, or some other opportunities, risk, agency, or some other

determinant of the optimal tradeoff between determinant of the optimal tradeoff between equity and debt. equity and debt.

inconsistentinconsistent

Pecking Pecking order theoryorder theory

Firms with upcoming investment opportunitiesFirms with upcoming investment opportunities

may reduce leverage to avoid issuing equity in may reduce leverage to avoid issuing equity in

the futurethe future..

InconsistentInconsistent

Managerial Managerial entrenchmeentrenchment theorynt theory

High market valuations allow managers to add High market valuations allow managers to add

equity but also allow them to become equity but also allow them to become entrenched, resisting the debt finance necessary entrenched, resisting the debt finance necessary to restore debt to the optimum.to restore debt to the optimum.

consistentconsistent

Market Market timing timing theorytheory

Capital structure is the cumulative outcome of Capital structure is the cumulative outcome of

attempts to time the equity market.attempts to time the equity market.consistentconsistent

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Capital Structure and Past Capital Structure and Past Market ValuationsMarket Valuations

DataData The whole sample includes 2,893 observations on firms that The whole sample includes 2,893 observations on firms that

went public between 1968 andwent public between 1968 and 19919988.. We require anWe require an IPO date for two reasonsIPO date for two reasons::

TThe IPO is itself an important financing decisionhe IPO is itself an important financing decision that is that is connected empirically to the market-to-book ratio.connected empirically to the market-to-book ratio.

Allow us to study the evolution of capital structure.Allow us to study the evolution of capital structure. We exclude financial firms, firms with a minimum book We exclude financial firms, firms with a minimum book

value of assets below $10 million, firms without completvalue of assets below $10 million, firms without complete data on total assets, and individual firm-year outliers foe data on total assets, and individual firm-year outliers for capital structure (book leverage is above one) and the r capital structure (book leverage is above one) and the market-to-book ratio (whic is above 10).market-to-book ratio (whic is above 10).

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Summary StatisticsSummary Statistics

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The main result of table I: The exist of The main result of table I: The exist of equity market timingequity market timing

Book leverage decreases sharply following the Book leverage decreases sharply following the IPO. Over the next 10 years, it rises slightly, IPO. Over the next 10 years, it rises slightly, while market value leverage rises more strongly; while market value leverage rises more strongly; this is indeed an age effect, not a survival effect.this is indeed an age effect, not a survival effect.

The decrease in market leverage reflects the The decrease in market leverage reflects the historically high market valuations prevailing at historically high market valuations prevailing at the end of the 1990s. The concurrent increase in the end of the 1990s. The concurrent increase in equity issues is suggestive of market timing. equity issues is suggestive of market timing.

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Determinants of Annual Changes Determinants of Annual Changes in Leveragein Leverage

Here we decompose Here we decompose the change in leveragethe change in leverage to exami to examine whether the effect comes through net equity issues,ne whether the effect comes through net equity issues, as market timing implies. as market timing implies.

We also use three other variables that Rajan and ZingWe also use three other variables that Rajan and Zingales (1995) find to be correlated to leverage in several ales (1995) find to be correlated to leverage in several developed countries: developed countries: asset tangibility, profitability, asset tangibility, profitability, and firm size.and firm size.

1010

1111

The results of panel A of table II are The results of panel A of table II are generally consistent with theoretical priors.generally consistent with theoretical priors.

Variables Variables (lagged value)(lagged value)

Expected signExpected sign Empirical signEmpirical sign

M/B ratioM/B ratio -- --PPE/A ratioPPE/A ratio ++ ++EBITDA/A ratioEBITDA/A ratio + or - --Log (S)Log (S) ++ ++f (D/A)f (D/A) When leverage is near one of these boundaries, theWhen leverage is near one of these boundaries, the

change in leverage can only go in one direction,change in leverage can only go in one direction,

regardless of the values of the other variables.regardless of the values of the other variables.

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The change in leverage can be The change in leverage can be decomposed as follows:decomposed as follows:

To regress each of these three components of changes in leverage on the market-to-book ratio and the other independent variables..

We further examine whether market-to-book affects leverage through net equity issues, as market timing implies.

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The clear result is that market-to-book The clear result is that market-to-book affects leverage through net equity affects leverage through net equity

issues.issues.

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Two interesting patterns are worth Two interesting patterns are worth noting:noting:

The The effect of profitabilityeffect of profitability on changes in leverage on changes in leverage arises primarily because of retained earnings. arises primarily because of retained earnings. Profitable firms issue less equity (+), but this effect is Profitable firms issue less equity (+), but this effect is

more than offset by higher retained earnings(-), so more than offset by higher retained earnings(-), so that the net effect of higher profits is to reduce that the net effect of higher profits is to reduce leverage.leverage.

Firm sizeFirm size plays an important role at the time of plays an important role at the time of the IPO. the IPO. Panel A shows that the reduction in leverage that Panel A shows that the reduction in leverage that

occurs at the IPO is much smaller for large firms.occurs at the IPO is much smaller for large firms. Panel B shows that large firms issue less equity.Panel B shows that large firms issue less equity.

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Determinants of LeverageDeterminants of Leverage

Market timing could be just a local Market timing could be just a local opportunism whose effect is quickly opportunism whose effect is quickly rebalanced away.rebalanced away.

If managers do not rebalance to some target If managers do not rebalance to some target leverage ratioleverage ratio market timing may have persistent effects, and market timing may have persistent effects, and historical valuations will help to explain why historical valuations will help to explain why

leverage ratios differ.leverage ratios differ. How to measure the relevant historical How to measure the relevant historical

variation in market valuations?variation in market valuations?

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A measure of historical variation in the A measure of historical variation in the market-to-book ratiomarket-to-book ratio

It is the “external finance weighted-average” market-to-book It is the “external finance weighted-average” market-to-book ratio. ratio. e e and and d d denote net equity and net debt issues, denote net equity and net debt issues, respectively.respectively.

The intuitive motivation for this weighting scheme is that The intuitive motivation for this weighting scheme is that external financing events represent practical opportunities to external financing events represent practical opportunities to change leverage. change leverage.

This variable takes high values for firms that raised external This variable takes high values for firms that raised external finance when the market-to-book ratio was high and vice-finance when the market-to-book ratio was high and vice-versa.versa.

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Univariate regressionUnivariate regression

First we evaluate the univariate explanatory pFirst we evaluate the univariate explanatory power of determinants of capital structure as cower of determinants of capital structure as corporations age.orporations age.

Where Where X X includes M/B, PPE/A, EBITDA/A, logincludes M/B, PPE/A, EBITDA/A, log(S), D/BE, D/ME, Dp/A and RD/A ratios.(S), D/BE, D/ME, Dp/A and RD/A ratios.

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Figure 1.Figure 1.

The growing gap between the dashed line and the solid line means that historical valuation information becomes increasingly relevant for firms.

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New light on the dynamics of capital New light on the dynamics of capital structure:structure:

The The weighted weighted average market-to-book, profitability average market-to-book, profitability and RD expense have stronger explanatory power.and RD expense have stronger explanatory power.

The weight scheme The weight scheme does not improvedoes not improve the performance the performance of all variables.of all variables.

Historical information adds incremental value only to Historical information adds incremental value only to market-to-book and profitabilitymarket-to-book and profitability..

When firms go public, their capital structure reflects a When firms go public, their capital structure reflects a number of factors, including number of factors, including market-to-book, asset market-to-book, asset tangibility, size and research and development tangibility, size and research and development intensity.intensity.

As firms age, the cross-section of leverage is more and As firms age, the cross-section of leverage is more and more explained by past financing opportunities, and more explained by past financing opportunities, and past opportunities to accumulate retained earnings.past opportunities to accumulate retained earnings.

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I. I. Capital Structure and Past Capital Structure and Past Market ValuationsMarket Valuations

Three separate ways to document the influence of past market valuations on capital structure is persistent.

1. Leverage regressions that control for the current M/B. (Table 3 & Table 4)

2. Regressions that control for the initial capital structure level and look at how subsequent fluctuations in M/B move capital structure away from initial level.(Table 5)

3. Direct looking at the power of lagged values of the weighted average M/B variable. (Regression system and Table 6)

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I. I. Capital Structure and Past Market Capital Structure and Past Market ValuationsValuations

C. Determinants of LeverageC. Determinants of Leverage (Multivariate regressions)(Multivariate regressions)

Table 3:Table 3: Multivariate regressions of book and market levera Multivariate regressions of book and market leverage on the weighted average M/B and the four Rajan and Zge on the weighted average M/B and the four Rajan and Zingales(1995) variables.ingales(1995) variables.

Regression model :Regression model :

The simultaneous inclusion of M/BThe simultaneous inclusion of M/Bt-1t-1 controls for current cross-secti controls for current cross-sectional variation in the onal variation in the level level of market-to-book. What is left for of market-to-book. What is left for M/BM/Befwefw

aa is the residual influence of is the residual influence of past, within-firm variation past, within-firm variation in market-tin market-to-book.o-book.

ttttttefwat

uSfA

EBITDAe

A

PPEd

B

Mc

B

Mba

A

D

11111,

log

2222

I. I. Capital Structure and Past Market Capital Structure and Past Market ValuationsValuations Results (Table 3):Results (Table 3):

1.1. M/BM/Befwaefwa enters with a negative coefficient and its effect is stronger anenters with a negative coefficient and its effect is stronger an

d more consistent than d more consistent than MM//BBt-1t-1, especially in book leverage., especially in book leverage.

2.2. The importance of historical valuation information is also aThe importance of historical valuation information is also apparent in the 1980 to 1999 All Firms sample.pparent in the 1980 to 1999 All Firms sample.

Historical within-firm variation in market-to-book, not current cross-fHistorical within-firm variation in market-to-book, not current cross-firm variation, is more important in explaining the cross section of leirm variation, is more important in explaining the cross section of leverageverage..

3.3. The weighted average market-to-book is generally the singThe weighted average market-to-book is generally the single most economically important of these variables.le most economically important of these variables.

4.4. As firms age, the effect of past market valuations becomes As firms age, the effect of past market valuations becomes even more prominent, consistent with the impressions froeven more prominent, consistent with the impressions from Figure 1.m Figure 1.

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I. I. Capital Structure and Past Market Capital Structure and Past Market ValuationsValuations

Table 4:Table 4: OLS and Fama–MacBeth regressions of leverage OLS and Fama–MacBeth regressions of leverage on determinants suggested by Fama and Frenchon determinants suggested by Fama and French((2000).2000).

Regression model :Regression model :

Results (Table 4):Results (Table 4):1.1. The coefficient on the weighted average market-to-booThe coefficient on the weighted average market-to-boo

k is not sensitive to this change in control variables.k is not sensitive to this change in control variables.

tttttt

ttttefwat

uAjiRDDA

RDh

A

Dpg

ME

Divf

BE

Dive

A

ETd

B

Mc

B

Mba

A

D

11111

1111,

log

2525

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D. PersistenceD. Persistence

Two main Two main results which have been results which have been documented:documented:

1.1. High market valuations reduce leverage in the short High market valuations reduce leverage in the short run.run.

2.2. Historically high market valuations are associated with Historically high market valuations are associated with lower leverage in the cross section.lower leverage in the cross section.

The connection between these two results must be that The connection between these two results must be that the M/B effect is very persistent.(Table 5 & Table 6 the M/B effect is very persistent.(Table 5 & Table 6 report the degree and magnitude of this persistence)report the degree and magnitude of this persistence)

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D. PersistenceD. Persistence

Table 5:Table 5: Regressions of cumulative changes in Regressions of cumulative changes in leverage from the pre-IPO value on the R&Z(1995) leverage from the pre-IPO value on the R&Z(1995) variables plus the pre-IPO value of leverage.variables plus the pre-IPO value of leverage.Regression model:Regression model:

The dependent variable includes the effect of the IPO itself. The dependent variable includes the effect of the IPO itself. This is useful because the IPO is a critical financing event This is useful because the IPO is a critical financing event known to be connected to market value.known to be connected to market value.

tIPOpre

ttt

ttefwaIPOpret

uA

DgSf

A

EBITDAe

A

PPEd

B

Mc

B

Mba

A

D

A

D

111

11,

log

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D. PersistenceD. Persistence

Estimation method: OLS and Fama-MacBeth regression Estimation method: OLS and Fama-MacBeth regression

Results(Table 5):Results(Table 5):1.1. The determinants of cumulative changes in leverage are esThe determinants of cumulative changes in leverage are es

sentially the same, in sign and magnitude, as the determinsentially the same, in sign and magnitude, as the determinants of leverage levels reported in Table III.ants of leverage levels reported in Table III.

2.2. The weighted average M/B is the most economically importThe weighted average M/B is the most economically important variable.ant variable.

3.3. The weighted average M/B result is unlikely to reflect an oThe weighted average M/B result is unlikely to reflect an omitted firm characteristic that would also influence initial lmitted firm characteristic that would also influence initial leverage.everage.

4.4. It provides more evidence that market valuations have effeIt provides more evidence that market valuations have effects on capital structure that persist and therefore accumulcts on capital structure that persist and therefore accumulate over time.ate over time.

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D. PersistenceD. PersistenceTable 6: Table 6: takes a direct look at the persistence of takes a direct look at the persistence of the effect of past valuations.the effect of past valuations.Regression system:Regression system:

Estimation method: Fama-MacBeth regressionEstimation method: Fama-MacBeth regression

The persistence of the market-to-book effect is measureThe persistence of the market-to-book effect is measured by a ratio of coefficients: bd by a ratio of coefficients: b22 divided by b divided by b11 or b or b33 divide divide

d by bd by b11.(trade-off theory).(trade-off theory)

ttttt

tefwat

ttttttefwat

ttttttefwat

uSfA

EBITDAe

A

PPEd

B

Mc

B

Mba

A

D

uSfA

EBITDAe

A

PPEd

B

Mc

B

Mba

A

D

uSfA

EBITDAe

A

PPEd

B

Mc

B

Mba

A

D

,3131

31

31

3,

33

,22222,

22

1,11111,

111

log

log

log

3131

D. PersistenceD. PersistenceFor each For each from 1 to 10, run a set of three regressions from 1 to 10, run a set of three regressions for each year for each year tt starting starting years prior to 1980 and years prior to 1980 and ending ending ss years prior to 1999 and record 20 sets of years prior to 1999 and record 20 sets of three coefficients. Only firms that survive three coefficients. Only firms that survive years are years are included so that each set of coefficients is calculated included so that each set of coefficients is calculated with the same sample of firms.with the same sample of firms.

1980 1999t

D/At+Control variables

Control variables

D/At+1

M/Befwa,t

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D. PersistenceD. PersistenceResults(Table 6):Results(Table 6):

1.1. The first and second columns show that this survival effect is The first and second columns show that this survival effect is small.small.

2.2. b2 and b3 both remain strongly significant for at least 10 years.b2 and b3 both remain strongly significant for at least 10 years.(b3 even control for current M/B and other characteristics)(b3 even control for current M/B and other characteristics)

3.3. In book values, b3 is several times the size of the c3 In book values, b3 is several times the size of the c3 coefficients. Thus the historical path of M/B, even calculated coefficients. Thus the historical path of M/B, even calculated with data over 10 years old, is much more influential than the with data over 10 years old, is much more influential than the current M/B.current M/B.

4.4. In market values, b3 is also substantial relative to c3.In market values, b3 is also substantial relative to c3.5.5. For book leverage, b2 divided by b1 is still 0.73 after 10 years; For book leverage, b2 divided by b1 is still 0.73 after 10 years;

73 percent of the initial effect is still apparent 10 years later. By 73 percent of the initial effect is still apparent 10 years later. By any practical definition, the effect is permanent.any practical definition, the effect is permanent.

6.6. The last columns report a lower bound estimate of this ratio, The last columns report a lower bound estimate of this ratio, calculated by drawing values of calculated by drawing values of bb1 and 1 and bb2 from the joint 2 from the joint distribution of the two estimates.distribution of the two estimates.

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IIII. . DiscussionDiscussion

A.A. Trade-off TheoryTrade-off TheoryMM(1958): MM(1958): capital structure is irrelevant.capital structure is irrelevant.The trade-off theory determines an optimal capital strThe trade-off theory determines an optimal capital structure by adding various imperfections.ucture by adding various imperfections.

Higher taxes on dividendsHigher taxes on dividends Higher nondebt tax shieldsHigher nondebt tax shields Higher costs of financial distressHigher costs of financial distress Investment opportunitiesInvestment opportunities Agency problemsAgency problems

Most relevant: costly financial distressMost relevant: costly financial distress Firms with substantial Firms with substantial growth and investment opportunitiesgrowth and investment opportunities hav hav

e the most to lose when overhanging debt prevents new capital fre the most to lose when overhanging debt prevents new capital from being raised or leads to an inefficient bankruptcy negotiation om being raised or leads to an inefficient bankruptcy negotiation during which some investment opportunities are forever lost.during which some investment opportunities are forever lost.Testable prediction: Testable prediction:

1.1. Capital structure eventually adjusts to changes in the M/B.Capital structure eventually adjusts to changes in the M/B.2.2. The past, temporary fluctuations captured in The past, temporary fluctuations captured in M/BM/Befwaefwa should no lonshould no lon

ger matter(b2 and b3 should be zero).ger matter(b2 and b3 should be zero).

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IIII. . DiscussionDiscussionA. Trade-off TheoryA. Trade-off Theory

Empirical evidence: past variation in market valuations Empirical evidence: past variation in market valuations is more important than several other variables is more important than several other variables suggested as determinants of the current optimum, suggested as determinants of the current optimum, including the current market valuation. including the current market valuation. inconsistent with inconsistent with Trade-off TheoryTrade-off Theory

B. Pecking Order TheoryB. Pecking Order TheoryRaising external finance is costly.(information, discount)There is no optimal capital structure.(There is no optimal capital structure.(deviating from optimum vs. external finance))Managers will follow a pecking order, using up internal funds first, then using up risky debt, and finally resorting to equity.In the absence of In the absence of investment opportunitiesinvestment opportunities, firms retain , firms retain profits and build up financial slack to avoid having to profits and build up financial slack to avoid having to raise external finance in the future.raise external finance in the future.

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IIII. . DiscussionDiscussion

B. Pecking Order TheoryB. Pecking Order TheoryStatic version: Static version: periods of high investment opportunities periods of high investment opportunities will tend to push leverage higher toward a debt will tend to push leverage higher toward a debt capacity.capacity.Empirical evidence: such periods tend to push Empirical evidence: such periods tend to push leverage lower.leverage lower.

inconsistent with static versioninconsistent with static version

Dynamic version: high growth firms reduce leverage in order to Dynamic version: high growth firms reduce leverage in order to avoid raising equity as investment opportunities arise in the avoid raising equity as investment opportunities arise in the future.(a relationship between leverage and future.(a relationship between leverage and futurefuture investment investment opportunities)opportunities)Empirical evidence: high M/B firms reduce leverage through Empirical evidence: high M/B firms reduce leverage through issuing equity, not through retaining earnings.(leverage is much issuing equity, not through retaining earnings.(leverage is much more strongly determined by more strongly determined by pastpast values of market-to-book.)values of market-to-book.)

inconsistent with dynamic versioninconsistent with dynamic version

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IIII. . DiscussionDiscussion

C. C. Managerial Entrenchment TheoryManagerial Entrenchment Theory

High valuations and good investment High valuations and good investment opportunities facilitate equity finance, but at the opportunities facilitate equity finance, but at the same time allow managers to become same time allow managers to become entrenched.entrenched.

This has a market-timing flavor, since managers This has a market-timing flavor, since managers issue equity when valuations are high and do issue equity when valuations are high and do not subsequently rebalance, but a very different not subsequently rebalance, but a very different interpretation.interpretation.Managers are not attempting to exploit new investors. Rather, they are exploiting existing investors ex post by not rebalancing.

Prior studies support the first view.Prior studies support the first view.

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IIII. . DiscussionDiscussionD. D. Market Timing TheoryMarket Timing Theory

Capital structure evolves as the cumulative outcome of past attempts tCapital structure evolves as the cumulative outcome of past attempts to time the equity market.o time the equity market.Two versions:Two versions:

1.1. Rational managers and investors and Rational managers and investors and adverse selection cosadverse selection coststs

2.2. Irrational investors ( or managers)Irrational investors ( or managers) and time-varying and time-varying mispricmispricinging

1.Adverse selection costs1.Adverse selection costs((information asymmetryinformation asymmetrycostcost))Firms tend to announce equity issues following releases of infFirms tend to announce equity issues following releases of inf

ormation, which may reduce ormation, which may reduce information asymmetryinformation asymmetry..Temporary fluctuations in the M/B measure variations in advTemporary fluctuations in the M/B measure variations in adv

erse selection.erse selection.If the costs of deviating from an optimal capital structure are If the costs of deviating from an optimal capital structure are

small compared to the resulting variation in issuing costs, psmall compared to the resulting variation in issuing costs, past variation in the M/B can then have long-lasting effects as ast variation in the M/B can then have long-lasting effects as we observe.we observe.

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IIII. . DiscussionDiscussion

D. D. Market Timing TheoryMarket Timing Theory2.2. MispricingMispricingManagers issue equity when they believe its cost is irratioManagers issue equity when they believe its cost is irratio

nally low and repurchase equity when they believe its conally low and repurchase equity when they believe its cost is irrationally high.st is irrationally high.

If managers are trying to exploit too-extreme expectationIf managers are trying to exploit too-extreme expectations, net equity issues will be positively related to M/B.s, net equity issues will be positively related to M/B.

If there is no optimal capital structure, managers need noIf there is no optimal capital structure, managers need not reverse these decisions when the firm appears to be cot reverse these decisions when the firm appears to be correctly valued and the cost of equity appears to be normrrectly valued and the cost of equity appears to be normal, leaving temporary fluctuations in M/B to have permaal, leaving temporary fluctuations in M/B to have permanent effects on leverage.nent effects on leverage.

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IIII. . DiscussionDiscussion

D. D. Market Timing TheoryMarket Timing TheoryEmpirical evidence:Empirical evidence:

1.1. The results support market timing theory, but do not The results support market timing theory, but do not discrimdiscriminate between these two versions of market timing.inate between these two versions of market timing.

2.2. The evidence that distinctly supports the mispricing vThe evidence that distinctly supports the mispricing version comes from the low long-run stock returns follersion comes from the low long-run stock returns following equity issues and the high long-run returns following equity issues and the high long-run returns following repurchases. (long-run abnormal returns to eqowing repurchases. (long-run abnormal returns to equity issuers vs. the announcement effects of equity isuity issuers vs. the announcement effects of equity issues )sues )

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IIII. . DiscussionDiscussion

TheoryOptimal capital

structure

Interpretations of M/B

Testable prediction

Empirical evidence

Trade-off Theory

Yes

Growth and investment opportunities(or risk, agency)

inconsistent

Pecking Order Theory

NoInvestment opportunities

inconsistent

Managerial Entrenchment Theory

No Market timing ----

Market Timing Theory

No

Market timing opportunities(mispricing or variations in adverse election)

Support but can not discriminate between these two versions

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III. III. ConclusionConclusion

Low-leverage firms tend to be those that Low-leverage firms tend to be those that raised funds when their valuations were raised funds when their valuations were high, and conversely high-leverage firms high, and conversely high-leverage firms tend to be those that raised funds when tend to be those that raised funds when their valuations were low.their valuations were low.Fluctuations in market valuations have large Fluctuations in market valuations have large effects on capital structure that persist for effects on capital structure that persist for at least a decade.at least a decade.Capital structure is largely the cumulative Capital structure is largely the cumulative outcome of past attempts to time the equity outcome of past attempts to time the equity market. market. support market timing theorysupport market timing theory

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Appendix:Appendix: Robustness tests Robustness tests (Table AI)(Table AI)

Leverage LevelLeverage Level

(Equation 5)(Equation 5)

Leverage Change Leverage Change from Pre-IPOfrom Pre-IPO

(Equation 6)(Equation 6)

SIC-3 fixed effectsSIC-3 fixed effects The effect of M/BThe effect of M/Befwaefwa on leverage: on leverage:

Panel A: Book Leverage %, IPO+10Panel A: Book Leverage %, IPO+10

Panel B: Book Leverage %, 1980–1999Panel B: Book Leverage %, 1980–1999

All FirmsAll Firms

Panel C: Market Leverage %, IPO+10Panel C: Market Leverage %, IPO+10

Panel D: Market Leverage %, 1980–Panel D: Market Leverage %, 1980–

1999 All Firms1999 All Firms

IPO-year fixed effectsIPO-year fixed effects

Retained earningsRetained earnings

Start M/B=End M/B

Outliers included

TobitTobit