Overvalued Equity and Financing Decisions
Ming Dong, David Hirshleifer, and Siew Hong Teoh
Review of Financial Studies, December 2012
Abstract
We test whether equity overvaluation affects corporate financing decisions using an ex ante misvaluation measure that filters firm scale and growth prospects from market price. We find that equity issuance and total financing by firms increase with equity overvaluation; but only among overvalued stocks. Also consistent with behavioral theories, we find that the sensitivity of equity issuance to misvaluation is greater than that of debt issuance, and that the sensitivity of equity issuance and total financing to misvaluation is stronger among small firms, growth firms and firms with high intangibles (low book-to-market or high R&D), firms with high turnover, and firms with high net insider selling. Overall, our evidence supports the hypothesis that overvalued equity affects financing decisions.
