Capital Structure and Security Issuance Under Heterogeneous Beliefs

49 Pages Posted: 19 Mar 2008 Last revised: 15 Dec 2010

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Jean-Sebastien Michel

HEC Montreal

Debarshi K. Nandy

Brandeis University - International Business School

An Yan

Fordham University - Gabelli School of Business

Date Written: November 14, 2010

Abstract

Using a sample of debt and seasoned equity issues from 1980-2004 and different proxies of investor optimism and the dispersion in investor beliefs, we empirically analyze, for the first time in the literature, the effect of heterogeneous beliefs among outside investors on the capital structure and security issuance choices made by a firm. The paper consists of three parts: In the first part of the paper, we study how heterogeneous beliefs affect a firm's choice between equity and debt for raising external financing; in the second part of the paper, we study the effect of heterogeneous beliefs on the price impact of a security issue on the firm's equity; and in the third part of the paper, we study the effect of heterogeneous beliefs on the long-term stock performance of equity and debt issuers. Our empirical results can be summarized as follows. First, the probability of a firm issuing equity rather than debt is increasing in both the average level of optimism of outside investors and the dispersion in outsider beliefs. Second, the price impact on the firm's equity is negative for an equity issue and zero for a debt issue; further, the price impact of an equity issue is decreasing (more negative) as the dispersion in outsider beliefs is greater. Finally, while the long-term stock returns to both equity and debt issuers is negative, the stock returns to equity issuers is significantly more negative than that of debt issuers. Further, the more optimistic outsiders are on average about a firm's prospects at the time of an equity issue and the more dispersed their beliefs, the more negative the long-term stock returns to the firm. Overall, our results indicate the importance of heterogeneity in investor beliefs as a determinant of the financing decision of a firm.

Keywords: Heterogeneous beliefs, Security Issuance, Price Impact, Capital Structure

JEL Classification: G32, G39

Suggested Citation

Chemmanur, Thomas J. and Michel, Jean-Sebastien and Nandy, Debarshi K. and Yan, An, Capital Structure and Security Issuance Under Heterogeneous Beliefs (November 14, 2010). EFA 2008 Athens Meetings Paper; AFA 2009 San Francisco Meetings Paper. Available at SSRN: https://ssrn.com/abstract=965923 or http://dx.doi.org/10.2139/ssrn.965923

Thomas J. Chemmanur

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Jean-Sebastien Michel

HEC Montreal ( email )

3000 Chemin de la Cote-Sainte-Catherine
Montreal, Quebec H3T 2A7
Canada
514-340-7153 (Phone)
514-340-5632 (Fax)

Debarshi K. Nandy (Contact Author)

Brandeis University - International Business School ( email )

Mailstop 32
Waltham, MA 02454-9110
United States

An Yan

Fordham University - Gabelli School of Business ( email )

113 West 60th Street
New York, NY 10023
United States
212-636-7401 (Phone)
212-765-5573 (Fax)

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