The Q-theory Explanation for the External Financing Effect: New Evidence

Abstract

Several studies document a robust negative association between net external financing and average stock returns, which is referred to as the external financing effect. Using total asset growth as a comprehensive measure of overall corporate investment and total profitability gross of R&D expenditures as a measure of true economic profitability, we provide new evidence in support of the q-theory explanation for the external financing effect. We also test the market timing explanation for the external financing effectbut fail to document supportive evidence.

Keywords: Cross-section of stock returns, External financing, Total profitability, q-theory of investment, R&D, Total asset growth

JEL Classification: G14, G31, G32, M41, M42