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Equity Market Misvaluation, Financing, and Investment

Missaka Warusawitharana () and Toni Whited ()

Review of Financial Studies, 2016, vol. 29, issue 3, 603-654

Abstract: We estimate a dynamic investment model in which firms finance with equity, cash, or debt. Misvaluation affects equity values, and firms optimally issue and repurchase overvalued and undervalued shares. The funds flowing to and from these activities come from investment, dividends, or net cash. The model fits a broad set of data moments in large heterogeneous samples and across industries. Our parameter estimates imply that misvaluation induces larger changes in financial policies than investment. The investment responses are strongest for small firms but nonetheless modest. Managers' rational responses to misvaluation increase shareholder value by up to 4%. Received January 7, 2014; accepted September 30, 2015 by Editor Leonid Kogan.

Date: 2016
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Working Paper: Equity market misvaluation, financing, and investment (2014) Downloads
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