IDEAS home Printed from https://ideas.repec.org/a/oup/rfinst/v29y2016i3p603-654..html
   My bibliography  Save this article

Equity Market Misvaluation, Financing, and Investment

Author

Listed:
  • Missaka Warusawitharana
  • Toni M. Whited

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.

Suggested Citation

  • Missaka Warusawitharana & Toni M. Whited, 2016. "Equity Market Misvaluation, Financing, and Investment," Review of Financial Studies, Society for Financial Studies, vol. 29(3), pages 603-654.
  • Handle: RePEc:oup:rfinst:v:29:y:2016:i:3:p:603-654.
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1093/rfs/hhv066
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to look for a different version below or search for a different version of it.

    Other versions of this item:

    References listed on IDEAS

    as
    1. Lee, Bong-Soo & Ingram, Beth Fisher, 1991. "Simulation estimation of time-series models," Journal of Econometrics, Elsevier, vol. 47(2-3), pages 197-205, February.
    2. Zhiguo He & Arvind Krishnamurthy, 2013. "Intermediary Asset Pricing," American Economic Review, American Economic Association, vol. 103(2), pages 732-770, April.
    3. Duffie, Darrell & Singleton, Kenneth J, 1993. "Simulated Moments Estimation of Markov Models of Asset Prices," Econometrica, Econometric Society, vol. 61(4), pages 929-952, July.
    4. Christopher A. Hennessy & Toni M. Whited, 2007. "How Costly Is External Financing? Evidence from a Structural Estimation," Journal of Finance, American Finance Association, vol. 62(4), pages 1705-1745, August.
    5. Skinner, Douglas J., 2008. "The evolving relation between earnings, dividends, and stock repurchases," Journal of Financial Economics, Elsevier, vol. 87(3), pages 582-609, March.
    6. Abel, Andrew B & Eberly, Janice C, 1994. "A Unified Model of Investment under Uncertainty," American Economic Review, American Economic Association, vol. 84(5), pages 1369-1384, December.
    7. Andrea L. Eisfeldt, 2004. "Endogenous Liquidity in Asset Markets," Journal of Finance, American Finance Association, vol. 59(1), pages 1-30, February.
    8. Gilchrist, Simon & Himmelberg, Charles P. & Huberman, Gur, 2005. "Do stock price bubbles influence corporate investment?," Journal of Monetary Economics, Elsevier, vol. 52(4), pages 805-827, May.
    9. Erickson, Timothy & Whited, Toni M., 2002. "Two-Step Gmm Estimation Of The Errors-In-Variables Model Using High-Order Moments," Econometric Theory, Cambridge University Press, vol. 18(3), pages 776-799, June.
    10. Brockman, Paul & Chung, Dennis Y., 2001. "Managerial timing and corporate liquidity: *1: evidence from actual share repurchases," Journal of Financial Economics, Elsevier, vol. 61(3), pages 417-448, September.
    11. Nicolae Gârleanu & Lasse Heje Pedersen, 2011. "Margin-based Asset Pricing and Deviations from the Law of One Price," Review of Financial Studies, Society for Financial Studies, vol. 24(6), pages 1980-2022.
    12. Han, Chirok & Phillips, Peter C. B., 2010. "Gmm Estimation For Dynamic Panels With Fixed Effects And Strong Instruments At Unity," Econometric Theory, Cambridge University Press, vol. 26(1), pages 119-151, February.
    13. Andrea Gamba & Alexander Triantis, 2008. "The Value of Financial Flexibility," Journal of Finance, American Finance Association, vol. 63(5), pages 2263-2296, October.
    14. Christopher A. Hennessy & Toni M. Whited, 2005. "Debt Dynamics," Journal of Finance, American Finance Association, vol. 60(3), pages 1129-1165, June.
    15. Shiller, Robert J, 1981. "Do Stock Prices Move Too Much to be Justified by Subsequent Changes in Dividends?," American Economic Review, American Economic Association, vol. 71(3), pages 421-436, June.
    16. Graham, John R. & Harvey, Campbell R., 2001. "The theory and practice of corporate finance: evidence from the field," Journal of Financial Economics, Elsevier, vol. 60(2-3), pages 187-243, May.
    17. Rafael La Porta & Florencio Lopez‐De‐Silanes & Andrei Shleifer, 1999. "Corporate Ownership Around the World," Journal of Finance, American Finance Association, vol. 54(2), pages 471-517, April.
    18. David McLean, R., 2011. "Share issuance and cash savings," Journal of Financial Economics, Elsevier, vol. 99(3), pages 693-715, March.
    19. Hayashi, Fumio, 1982. "Tobin's Marginal q and Average q: A Neoclassical Interpretation," Econometrica, Econometric Society, vol. 50(1), pages 213-224, January.
    20. Dirk Jenter & Katharina Lewellen & Jerold B. Warner, 2011. "Security Issue Timing: What Do Managers Know, and When Do They Know It?," Journal of Finance, American Finance Association, vol. 66(2), pages 413-443, April.
    21. Jose A. Scheinkman & Wei Xiong, 2003. "Overconfidence and Speculative Bubbles," Journal of Political Economy, University of Chicago Press, vol. 111(6), pages 1183-1219, December.
    22. Whited, Toni M, 1992. "Debt, Liquidity Constraints, and Corporate Investment: Evidence from Panel Data," Journal of Finance, American Finance Association, vol. 47(4), pages 1425-1460, September.
    23. Timothy Erickson & Toni M. Whited, 2012. "Treating Measurement Error in Tobin's q," Review of Financial Studies, Society for Financial Studies, vol. 25(4), pages 1286-1329.
    24. Bolton, Patrick & Chen, Hui & Wang, Neng, 2013. "Market timing, investment, and risk management," Journal of Financial Economics, Elsevier, vol. 109(1), pages 40-62.
    25. DeAngelo, Harry & DeAngelo, Linda & Whited, Toni M., 2011. "Capital structure dynamics and transitory debt," Journal of Financial Economics, Elsevier, vol. 99(2), pages 235-261, February.
    26. repec:hrv:faseco:30747162 is not listed on IDEAS
    27. Shane A. Corwin, 2003. "The Determinants of Underpricing for Seasoned Equity Offers," Journal of Finance, American Finance Association, vol. 58(5), pages 2249-2279, October.
    28. Lucian A. Taylor, 2010. "Why Are CEOs Rarely Fired? Evidence from Structural Estimation," Journal of Finance, American Finance Association, vol. 65(6), pages 2051-2087, December.
    29. Vermaelen, Theo, 1981. "Common stock repurchases and market signalling : An empirical study," Journal of Financial Economics, Elsevier, vol. 9(2), pages 139-183, June.
    30. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-1335, November.
    31. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
    32. Asquith, Paul & Mullins, David Jr., 1986. "Equity issues and offering dilution," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 61-89.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Foucault , Thierry & Dessaint , Olivier & Frésard, Laurent & Matray, Adrien, 2015. "Ripple Effects of Noise on Corporate Investment," HEC Research Papers Series 1127, HEC Paris.
    2. Pástor, Luboš & Stambaugh, Robert F. & Taylor, Lucian, 2019. "Sustainable Investing in Equilibrium," CEPR Discussion Papers 14171, C.E.P.R. Discussion Papers.
    3. Xing Guo, 2020. "Identifying Aggregate Shocks with Micro-level Heterogeneity: Financial Shocks and Investment Fluctuation," Staff Working Papers 20-17, Bank of Canada.
    4. Antonio Falato & Dalida Kadyrzhanova & Jae W. Sim, 2013. "Rising intangible capital, shrinking debt capacity, and the US corporate savings glut," Finance and Economics Discussion Series 2013-67, Board of Governors of the Federal Reserve System (U.S.), revised 2013.
    5. Oliver Levine & Brent Glover, 2014. "Idiosyncratic Risk and the Manager," 2014 Meeting Papers 736, Society for Economic Dynamics.
    6. Ahrends, Meike & Drobetz, Wolfgang & Puhan, Tatjana Xenia, 2018. "Cyclicality of growth opportunities and the value of cash holdings," Journal of Financial Stability, Elsevier, vol. 37(C), pages 74-96.
    7. Sloan, Richard G. & You, Haifeng, 2015. "Wealth transfers via equity transactions," Journal of Financial Economics, Elsevier, vol. 118(1), pages 93-112.
    8. Antonio Falato & Jae W. Sim, 2014. "Why Do Innovative Firms Hold So Much Cash? Evidence from Changes in State R&D Tax Credits," Finance and Economics Discussion Series 2014-72, Board of Governors of the Federal Reserve System (U.S.), revised 21 May 2014.
    9. Bakke, Tor-Erik & Gu, Tiantian, 2017. "Diversification and cash dynamics," Journal of Financial Economics, Elsevier, vol. 123(3), pages 580-601.
    10. Aydoğan Alti & Paul C. Tetlock, 2014. "Biased Beliefs, Asset Prices, and Investment: A Structural Approach," Journal of Finance, American Finance Association, vol. 69(1), pages 325-361, February.
    11. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.
    12. Gregor Matvos, 2013. "Estimating the Benefits of Contractual Completeness," Review of Financial Studies, Society for Financial Studies, vol. 26(11), pages 2798-2844.
    13. Nyborg, Kjell G & Wang,, 2019. "Corporate cash holdings: Stock liquidity and the repurchase motive," CEPR Discussion Papers 13791, C.E.P.R. Discussion Papers.
    14. Sun, Qi & Xiaolan, Mindy Z., 2019. "Financing intangible capital," Journal of Financial Economics, Elsevier, vol. 133(3), pages 564-588.
    15. Ming Dong & David Hirshleifer & Siew Hong Teoh, 2017. "Misvaluation and Corporate Inventiveness," NBER Working Papers 24142, National Bureau of Economic Research, Inc.
    16. Li, Di & Taylor, Lucian A. & Wang, Wenyu, 2018. "Inefficiencies and externalities from opportunistic acquirers," Journal of Financial Economics, Elsevier, vol. 130(2), pages 265-290.
    17. Joan Farre-Mensa & Alexander Ljungqvist, 2016. "Do Measures of Financial Constraints Measure Financial Constraints?," Review of Financial Studies, Society for Financial Studies, vol. 29(2), pages 271-308.
    18. Andrea L. Eisfeldt & Tyler Muir, 2014. "Aggregate External Financing and Savings Waves," NBER Working Papers 20442, National Bureau of Economic Research, Inc.
    19. Min Maung & Reza H. Chowdhury, 2014. "Is there a right time for corporate investment?," Studies in Economics and Finance, Emerald Group Publishing, vol. 31(2), pages 223-243, May.
    20. Sun, Qi & Xiaolan, Mindy Z., 2019. "Financing intangible capital," Journal of Financial Economics, Elsevier, vol. 132(2), pages 472-496.
    21. Shah, Imran Hussain & Schmidt-Fischer, Francesca & Malki, Issam & Hatfield, Richard, 2019. "A structural break approach to analysing the impact of the QE portfolio balance channel on the US stock market," International Review of Financial Analysis, Elsevier, vol. 64(C), pages 204-220.
    22. Ryan Michaels & T Beau Page & Toni M Whited, 2019. "Labor and Capital Dynamics under Financing Frictions," Review of Finance, European Finance Association, vol. 23(2), pages 279-323.
    23. Frederico Belo & Chen Xue & Lu Zhang, 2013. "A Supply Approach to Valuation," Review of Financial Studies, Society for Financial Studies, vol. 26(12), pages 3029-3067.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:oup:rfinst:v:29:y:2016:i:3:p:603-654.. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Oxford University Press). General contact details of provider: http://edirc.repec.org/data/sfsssea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.