Why Do Firms Issue Equity?

Authors

  • AMY DITTMAR,

  • ANJAN THAKOR

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    • Dittmar is at University of Michigan Business School, Ann Arbor, Michigan and Thakor is at John M. Olin School of Business, Washington University in Saint Louis. Without implicating them for possible errors on our part, we would like to thank Sreedhar Bharath, Kent Daniels, Andrew Ellul, Bob Jennings, Clemens Sialm, Rob Stambaugh, Ivo Welch, and seminar participants at the University of Michigan, University of Oregon, University of New Orleans, and University of Toronto, and particularly an anonymous referee and an associate editor for many useful suggestions. We would also like to thank Brad Bernatek, Brandon Fleming, and Amrita Nain for excellent research assistance, and Art Durnev and Nejat Seyhun for supplying some of the data.


ABSTRACT

We develop and test a new theory of security issuance that is consistent with the puzzling stylized fact that firms issue equity when their stock prices are high. The theory also generates new predictions. Our theory predicts that managers use equity to finance projects when they believe that investors' views about project payoffs are likely to be aligned with theirs, thus maximizing the likelihood of agreement with investors. Otherwise, they use debt. We find strong empirical support for our theory and document its incremental explanatory power over other security-issuance theories such as market timing and time-varying adverse selection.

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