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Equity Market Misvaluation, Financing, and Investment

60 Pages Posted: 6 Sep 2012 Last revised: 7 Nov 2014

Missaka Warusawitharana

Board of Governors of the Federal Reserve System

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Multiple version iconThere are 2 versions of this paper

Date Written: November 6, 2014

Abstract

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 3%.

Keywords: equity misvaluation, financing, investment

JEL Classification: G31, G32, G35

Suggested Citation

Warusawitharana, Missaka and Whited, Toni M., Equity Market Misvaluation, Financing, and Investment (November 6, 2014). Available at SSRN: https://ssrn.com/abstract=2142209 or http://dx.doi.org/10.2139/ssrn.2142209

Missaka Warusawitharana

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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