Equity Market Misvaluation, Financing, and Investment

We estimate a dynamic investment model in which firms finance with equity, cash, or debt. Misvaluation affects equity values, and firms optimally issue and repurchase overvalued and undervalued shares. The funds flowing to and from these activities come from investment, dividends, or net cash. The m...

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Bibliographic Details
Published in:The Review of financial studies 2016-03, Vol.29 (3), p.603-654
Main Authors: Warusawitharana, Missaka, Whited, Toni M.
Format: Article
Language:English
Subjects:
Autocorrelation
Cash
Corporate finance
Cost of equity
Dividends
Equity
Financial transactions
Investment advisors
Investments
Market value
Repurchasing
Securities buybacks
Securities markets
Shareholders
Shareholders wealth
Simulations
Standard deviation
Studies
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Summary:We estimate a dynamic investment model in which firms finance with equity, cash, or debt. Misvaluation affects equity values, and firms optimally issue and repurchase overvalued and undervalued shares. The funds flowing to and from these activities come from investment, dividends, or net cash. The model fits a broad set of data moments in large heterogeneous samples and across industries. Our parameter estimates imply that misvaluation induces larger changes in financial policies than investment. The investment responses are strongest for small firms but nonetheless modest. Managers' rational responses to misvaluation increase shareholder value by up to 4%.
ISSN:0893-9454
1465-7368
DOI:10.1093/rfs/hhv066