Behavioral and Rational Explanations of Stock Price Performance around SEOs: Evidence from a Decomposition of Market-to-Book Ratios

Michael G. Hertzel and Zhi Li

Journal of Financial and Quantitative Analysis, 2010, vol. 45, issue 4, 935-958

Abstract: We examine the extent to which investment opportunities and/or mispricing motivate equity issuance and contribute to post-issue stock underperformance. We decompose market-to-book ratios into misvaluation and growth option components and find that issuing firms are both overvalued and have greater growth opportunities relative to nonissuers. Firms with greater growth opportunities invest more in capital expenditures and research and development (R&D) after issuance but do not experience lower post-issue stock returns. In contrast, issuing firms with greater mispricing tend to decrease long-term debt and/or increase cash holdings and do earn lower returns. Our findings are consistent with behavioral explanations for post-issue stock price underperformance.

Date: 2010
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