Market Timing and Capital Structure_Wurgler_JF_02

MarketTimingandCapitalStructureMALCOLMBAKERandJEFFREYWURGLER*ABSTRACTItiswellknownthatfirmsaremorelikelytoissueequitywhentheirmarketvaluesarehigh,relativetobookandpastmarketvalues,andtorepurchaseequitywhentheirmarketvaluesarelow.Wedocumentthattheresultingeffectsoncapitalstructureareverypersistent.Asaconsequence,currentcapitalstructureisstronglyrelatedtohistoricalmarketvalues.Theresultssuggestthetheorythatcap-italstructureisthecumulativeoutcomeofpastattemptstotimetheequitymarket.INCORPORATEFINANCE,“equitymarkettiming”referstothepracticeofissuingsharesathighpricesandrepurchasingatlowprices.Theintentionistoexploittemporaryfluctuationsinthecostofequityrelativetothecostofotherformsofcapital.Intheefficientandintegratedcapitalmarketsstud-iedbyModiglianiandMiller~1958!,thecostsofdifferentformsofcapitaldonotvaryindependently,sothereisnogainfromopportunisticallyswitchingbetweenequityanddebt.Incapitalmarketsthatareinefficientorseg-mented,bycontrast,markettimingbenefitsongoingshareholdersattheexpenseofenteringandexitingones.Managersthushaveincentivestotimethemarketiftheythinkitispossibleandiftheycaremoreaboutongoingshareholders.Inpractice,equitymarkettimingappearstobeanimportantaspectofrealcorporatefinancialpolicy.Thereisevidenceformarkettiminginfourdifferentkindsofstudies.First,analysesofactualfinancingdecisionsshowthatfirmstendtoissueequityinsteadofdebtwhenmarketvalueishigh,relativetobookvalueandpastmarketvalues,andtendtorepurchaseequitywhenmarketvalueislow.1Second,analysesoflong-runstockreturnsfol-*BakerisfromtheHarvardUniversityGraduateSchoolofBusinessAdministration.WurglerisfromtheNewYorkUniversitySternSchoolofBusiness.WethankArturoBris,JohnCampbell,PaulGompers,RogerIbbotson,AndrewRoper,GeertRouwenhorst,GeoffVerter,RalphWalkling,participantsofseminarsatColumbia,Cornell,Duke,Harvard,INSEAD,MIT,Northwestern,NYU,Rutgers,Stanford,UniversityofChicago,UniversityofNorthCarolinaatChapelHill,UniversityofNotreDame,Wharton,andYale,andespeciallyRichardGreen,AndreiShleifer,JeremyStein,IvoWelch,andananonymousrefereeforhelpfulcomments.WethankJohnGrahamandJayRit-terfordataandAlokKumarforresearchassistance.BakergratefullyacknowledgesthefinancialsupportoftheDivisionofResearchoftheHarvardGraduateSchoolofBusinessAdministration.1SeasonedequityissuescoincidewithhighvaluationsinTaggart~1977!,Marsh~1982!,AsquithandMullins~1986!,Korajczyk,Lucas,andMcDonald~1991!,Jung,Kim,andStulz~1996!,andHovakimian,Opler,andTitman~2001!.InitialpublicequityissuescoincidewithhighvaluationsinLoughran,Ritter,andRydqvist~1994!andPagano,Panetta,andZingales~1998!.RepurchasescoincidewithlowvaluationsinIkenberry,Lakonishok,andVermaelen~1995!.THEJOURNALOFFINANCE•VOL.LVII,NO.1•FEB.20021lowingcorporatefinancedecisionssuggestthatequitymarkettimingissuc-cessfulonaverage.Firmsissueequitywhenthecostofequityisrelativelylowandrepurchaseequitywhenthecostisrelativelyhigh.2Third,analysesofearningsforecastsandrealizationsaroundequityissuessuggestthatfirmstendtoissueequityattimeswheninvestorsarerathertooenthusiasticaboutearningsprospects.3Fourth,andperhapsmostconvincing,managersadmittomarkettiminginanonymoussurveys.GrahamandHarvey~2001!findthattwo-thirdsofCFOsagreethat“theamountbywhichourstockisundervaluedorovervaluedwasanimportantorveryimportantconsider-ation”inissuingequity,andnearlyasmanyagreethat“ifourstockpricehasrecentlyrisen,thepriceatwhichwecansellis‘high’”~p.216!.Inthatsurveyasawhole,equitymarketpricesareregardedasmoreimportantthan9outof10otherfactorsconsideredinthedecisiontoissuecommonstock,andmoreimportantthanall4otherfactorsconsideredinthedecisiontoissueconvertibledebt.Inthispaper,weaskhowequitymarkettimingaffectscapitalstructure.Thebasicquestioniswhethermarkettiminghasashort-runoralong-runim-pact.Oneexpectsatleastamechanical,short-runimpact.However,iffirmssubsequentlyrebalanceawaytheinfluenceofmarkettimingfinancingde-cisions,asnormativecapitalstructuretheoryrecommends,thenmarkettim-ingwouldhavenopersistentimpactoncapitalstructure.Thesignificanceofmarkettimingforcapitalstructureisthereforeanempiricalissue.Ourresultsareconsistentwiththehypothesisthatmarkettiminghaslarge,persistenteffectsoncapitalstructure.Themainfindingisthatlowleveragefirmsarethosethatraisedfundswhentheirmarketvaluationswerehigh,asmeasuredbythemarket-to-bookratio,whilehighleveragefirmsarethosethatraisedfundswhentheirmarketvaluationswerelow.Wedocumentthisintraditionalcapitalstructureregressions.Leverageisthedependentvariableandthe“externalfinanceweighted-average”market-to-bookratioistheindependentvariable.Thisvariableisaweightedaverageofafirm’spastmarket-to-bookratioswhich,forexample,takeshighvaluesforfirmsthatraisedtheirexternalfinance—equityordebt—whentheirmarket-to-bookratioswerehigh.Thebasicregressionresultisthatleverageisstronglynegativelyrelatedtothismeasureofhistoricalmarketvaluations.2Netofadverseannouncementeffects,equityissuershavelowsubsequent~idiosyncratic!returnsinStigler~1964!,Ritter~1991!,LoughranandRitter~1995!,SpeissandAffleck-Graves~1995!,BravandGompers~1997!,andJegadeesh~2000!,and