Cross-Market Timing in Security Issuance

Pengjie Gao and Dong Lou

FMG Discussion Papers from Financial Markets Group

Abstract: The conventional view of market timing suggests an unambiguous, negative relation between equity misvaluation and the equity share in new issues|that is, rms with overvalued equity issue more equity and, all else equal, less debt. We question this conventional view in the paper. Using price pressure resulting from mutual funds' ow-induced trading to identify equity misvaluation, we rst show that equity and debt prices are a ected by the same shocks, but to di erent degrees. Next, we document substantial cross-sectional variation in the sensitivity of issuance decisions to equity misvaluation. In particular, rms with sucient internal resources increase equity issues and yet decrease debt issues in our measure of equity misvaluation; in contrast, rms that are heavily dependent on external nance increase both equity and debt issues, to take advantage of the misvaluation in both. In sum, this paper provides evidence that equity and debt can be jointly (mis)priced, and more important, examines the resulting impact on rms' issuance decisions.

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