Further Evidence on the Financing Deficit: The Impact of Market Timing

Abstract:     
Using a multi-period valuation model, we examine the impact of market misvaluation on the firm's choice of security for funding the financing deficit. We find that firms which appear to be overvalued relative to previous years, fund a greater proportion of their deficit with equity rather than debt. These findings are robust to firm size, different time periods and other variables, which are known to impact the capital structure choice. We also find evidence that the high market valuations of the 1990s led to equity being increasingly preferred over debt during that time period. Our results indicate that, for a broad set of firms, market timing explains some of the variation in the deficit coefficient.

Number of Pages in PDF File: 32

Keywords: Capital Structure, Pecking Order Theory, Market Timing, Residual Income Model

JEL Classification: G30, G32

working papers series