Equity Financing Risk

55 Pages Posted: 21 Dec 2017 Last revised: 31 Jan 2019

See all articles by Mamdouh Medhat

Mamdouh Medhat

City University London - Sir John Cass Business School

Berardino Palazzo

Federal Reserve Board

Multiple version iconThere are 2 versions of this paper

Date Written: January 30, 2019

Abstract

We develop a model of equity financing risk (EFR; i.e., risky equity issuance costs) to study the joint effects of precautionary savings and research and development (R&D) investments on expected returns. Our evidence confirms the model: (1) financial slack (i.e., liquid assets relative to R&D) lowers EFR exposure and thereby expected returns, (2) equity issuance lowers expected returns by increasing financial slack, and (3) these effects are concentrated among unprofitable firms. Moreover, an EFR factor yields a premium of 1.45% per month (t = 4.80), subsumes the Fama-French (2015) and Hou-Xue-Zhang (2015) investment factors, and helps explain anomalies related to R&D and cash-based operating profitability.

Keywords: Equity returns, R&D, financing constraints, equity issuances, factor models

JEL Classification: G12, G31, G35

Suggested Citation

Medhat, Mamdouh and Palazzo, Berardino, Equity Financing Risk (January 30, 2019). Available at SSRN: https://ssrn.com/abstract=3089792 or http://dx.doi.org/10.2139/ssrn.3089792

Mamdouh Medhat

City University London - Sir John Cass Business School ( email )

106 Bunhill Row
London, EC1Y 8TZ
United Kingdom

HOME PAGE: http://https://sites.google.com/site/mamdouhmedhatresearch/

Berardino Palazzo (Contact Author)

Federal Reserve Board ( email )

1801 K street NW
Washington, DC 20036
United States

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