Equity Issues, Creditor Control and Market Timing Patterns: Evidence From Leverage Decreasing Recapitalizations

Abstract

We contribute to the literature on “market timing” by exploring periods of simultaneous equity issues and debt retirements (a leverage decreasing recapitalization, LDR). Contrary to traditional equity issues, LDRs are predicted by measures of creditor control whereas capital investment has no such predictive power. Nevertheless, LDRs occur after stock price run- ups and in periods of high valuation which subsequently decrease. The valuation dynamics are robust and also obtain for subsamples of LDR firms violating financial covenants. A comparison to debt retirements financed by illiquid asset sales and an analysis of discretionary cost items further corroborates the interpretation that LDR firms successfully “time the market” to finance the debt retirement.

Keywords: equity issue; market timing; creditor control; financial reporting conservatism; covenants; pro-forma cash holdings

JEL Classification: G30, G32, G34, M40, M41