A Theory of Capital Structure, Price Impact, and Long-Run Stock Returns under Heterogeneous Beliefs
Review of Corporate Finance Studies (RCFS), September 2015, 4 (2), 258-320
68 Pages Posted: 19 Mar 2010 Last revised: 5 May 2016
Date Written: May 1, 2015
We study an environment with short sale constraints and heterogeneous beliefs among outsiders and between insiders and outsiders. Firm insiders choose between equity, debt, and convertible debt to raise external financing. We analyze two settings: one where heterogeneous beliefs is the only market imperfection and another where there are significant security issue and financial distress costs. Our model generates a pecking order of external financing different from asymmetric information models, and new predictions for capital structure, sequential tranching of securities, the price impact of security issues, and long-run stock returns. It also provides a new rationale for convertible debt issuance.
Keywords: Capital Structure, Heterogeneous Beliefs, Convertible Debt Issues, Security Tranching, Price Impact, Long-Run Stock Returns.
JEL Classification: G32
Suggested Citation: Suggested Citation