PRESENTACIÓN DE RESULTADOS 5.1 Análisis e Interpretación de Resultados

This section develops the testable hypotheses from the literature reviewed in the preceding sections. This section consists of four subsections related to each developed hypothesis that are tested in Chapter 6 of the thesis. Subsection 2.5.1 discusses the hypothesis about share issuance and internal financial constraints while subsection 2.5.2 explains the hypothesis about share issuance and external financial constraints. In subsection 2.5.3, the hypothesis that share issuance and financial constraints depends on firm size is developed. Finally, subsection 2.5.4 explains the hypothesis that share issuance decisions affect stock returns.

2.5.1. Share Issuance and Internal Financial Constraints

The extant literature provides strong support for equity issues that precede periods of stock overvaluation or prior stock price run-ups (Graham and Harvey, 2001; Baker and Wurgler, 2002). As explained in Section 2.2, equity issues depend on factors such as costs of adverse selection associated with equity issues (Myers and Majluf, 1984; Lucas and McDonald, 1990; Korajczyk et al., 1992). Again, the empirical evidence reveals that equity issues are associated with negative asymmetric information effects when they need external equity financing. Therefore, consistent with a pecking order theory, firms avoid this cost by utilising internal cash or issue debt when they require additional financing (Myers and Majluf, 1984; Shyam-Sunder and Myers, 1999; Lemmon and Zender, 2010). Baker and Wurgler (2002) explain that the effects of asymmetric information correlate with overvalued equity or mispricing. Thus, the issue of overvalued equity coincides with high asymmetric information effects. This implies even when firms face significantly high asymmetric information effects associated with equity issues, the motivation to issue overvalued equity for market price exploitation

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overrules the convention that firms issue equity during periods of low information asymmetry.

According to the trade-off theory, firms attempt to maintain a balanced capital structure based on a target debt-equity ratio (Shyam-Sunder and Myers, 1999; Hovakimian et al., 2001). Financial deficit is crucial in determining when firms issue securities. Given the high costs of adverse selection equity issues only enable firms to balance its excessive leverage position. Thus, at high leverage any additional debt issues will potentially drag the firm into costly financial distress and bankruptcy, even though debt issues produce tax advantage. This means the combination of potential discounting of the stock price and relatively high transaction costs does not encourage firms to undertake equity offerings. At high stock prices, firms are motivated to make equity offerings, but they must also possess the financial capacity to pay the high ancillary costs of issue. Opportunistic managers that issue/repurchase securities on the basis of the stock price must have the financial strength to also deal with costs (especially for equity issues) incidental to accessing the external capital market.

The direct costs such as gross fees paid to investment banks in conducting seasoned equity offering could be considerably high (Butler, Grullon, and Weston, 2005). For example, Lee et al. (1996) find that the average firm pays around 7% of the total proceeds to raise capital through an SEO. If firms only time their issues, then it is expected that they have substantial financial slack, especially for equity issuers. Without adequate investment opportunities cash- strapped entities are less inclined to access equity financing. Growth options dominate the demand for cash, and hence the need to obtain external financing when there is internal deficit. DeAngelo et al. (2010) stress that it is only the

need for “near term” cash for future investments that motivates equity issue at high valuations. Firms that require cash for identified projects contact the outside investing public for financing without regard for market timing activities. It presupposes that rate of investment should increase with equity issues.

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Moreover, Fama and French (2005) and Dong et al. (2012) contend that equity issuing firms are actually cash-rich. These firms do not necessarily require external financing. So following the argument by Baker and Wurgler (2002), and the evidence from Fama and French (2005) and Dong et al. (2012) and the high costs of equity issuance, one can conclude that timing the issue of overvalued equity should be more pronounced for cash-rich firms than it would be for cash-poor ones. Thus, for market timing to hold, equity issues must track financial surplus. This means managers that time the market should not be financially constrained. The only motivation for any equity offering should be occasioned by high stock prices with substantial financial slack such that high transaction costs do not impair the ability to conduct the issue. Firms are typically opportunistic and will issue equity/repurchase at high/low valuations. Fama and French (2005) highlight this proposition and find that equity issuers are not constrained with cash rather these entities hold significant cash balances prior to the issue. While this lends credence to market timing theory, it weakens the position of the pecking order phenomenon. Issue of overvalued equity under the market timing theory undermines the effects of pecking order theory. Stated differently, financial constraints do not curtail equity issue when firms with timing prospects issue equity. Therefore, equity issuers are less financially constrained and M/B suppresses factors that support pecking order (Dong et al, 2012).

The hypothesis following the above discussions is stated as follows:

H1: There is high probability for less internally financially