Download this Paper Open PDF in Browser

Does Market Timing or Enhanced Pecking Order Determine Capital Structure?

48 Pages Posted: 19 Sep 2004  

Peter Högfeldt

Stockholm School of Economics - Department of Finance; European Corporate Governance Institute (ECGI)

Andris Oborenko

Stockholm School of Economics - Department of Finance

Date Written: March 2005

Abstract

We explore the idea that a firm's financing behavior depends crucially on how its ownership structure affects the cost differential between internal and external equity. If ownership is dispersed, the cost differential is relatively small. By issuing public offers when market-to-book values are high, incumbent shareholders benefit if equity is mispriced. The market timing theory predicts that firms' lower leverage is mainly the cumulative result of successful market timings. But if ownership (capital) is separated from control (votes), agency costs due to widespread use of dual-class shares drive a wedge between the costs of internal and external equity as new external shareholders demand compensation. This generates an enhanced pecking order: new equity (rights issues or private placements) is issued only when internal equity and debt are insufficient while public offers are not used since compensating transfers from incumbents to external shareholders needed. The behavior of US IPO firms is consistent with the market timing theory (Baker and Wurgler (2002)) while the enhanced pecking order theory best explains how Swedish IPO firms behave and why market timing is not important. Our results challenge the generality of the market timing theory.

Keywords: Capital structure, market timing, enhanced pecking order, dual-class shares, profitability, retained earnings, persistent effects, seasoned equity offerings, public offers

JEL Classification: G32

Suggested Citation

Högfeldt, Peter and Oborenko, Andris, Does Market Timing or Enhanced Pecking Order Determine Capital Structure? (March 2005). European Corporate Governance Institute (ECGI) Research Paper No. 072/2005. Available at SSRN: https://ssrn.com/abstract=592501 or http://dx.doi.org/10.2139/ssrn.592501

Peter Högfeldt (Contact Author)

Stockholm School of Economics - Department of Finance ( email )

Box 6501
SE-113 83 Stockholm
Sweden
+46 8 7169151 (Phone)

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Andris Oborenko

Stockholm School of Economics - Department of Finance ( email )

SE-113 83 Stockholm
Sweden

Paper statistics

Downloads
1,175
Rank
13,731
Abstract Views
4,123