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A Theory of Capital Structure, Price Impact, and Long-Run Stock Returns under Heterogeneous Beliefs

Onur Bayar, Thomas Chemmanur and Mark H. Liu

Review of Corporate Finance Studies, 2015, vol. 4, issue 2, 258-320

Abstract: We study an environment with short-sale constraints and heterogeneous beliefs among outsiders and between insiders and outsiders. Firm insiders choose between equity, debt, and convertible debt to raise external financing. We analyze two settings: one in which heterogeneous beliefs is the only market imperfection and another in which there are significant security issue and financial distress costs. Our model generates a pecking order of external financing different from asymmetric information models, and new predictions for capital structure, sequential tranching of securities, the price impact of security issues, and long-run stock returns. We also provide a new rationale for convertible debt issuance.

Date: 2015
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