American Finance Association
Market Timing and Capital Structure
Author(s): Malcolm Baker and Jeffrey Wurgler
Source: The Journal of Finance, Vol. 57, No. 1 (Feb., 2002), pp. 1-32 Published by: Wiley for the American Finance Association
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THE JOURNAL OF FINANCE * VOL. LVII, NO. 1 * FEB. 2002
Market Timing and Capital Structure
MALCOLMBAKER and JEFFREY WURGLER"
It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to historical market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market.
FINANCE,"equity market timing" refers to the practice of issuing IN CORPORATE
shares at high prices and repurchasing at low prices. The intention is to exploit temporary fluctuations in the cost of equity relative to the cost of other forms of capital. In the efficient and integrated capital markets studied by Modigliani and Miller (1958), the costs of different forms of capital do not vary independently, so there is no gain from opportunistically switching between equity and debt. In capital markets that are inefficient or segmented, by contrast, market timing benefits ongoing shareholders at the expense of entering and exiting ones. Managers thus have incentives to time the market if they think it is possible and if they care more about ongoing shareholders.
In practice, equity market timing appears to be an important aspect of real corporate financial policy. There is evidence for market timing in four different kinds of studies. First, analyses of actual financing decisions show that firms tend to issue equity instead of debt when market value is high, relative to book value and past market values, and tend to repurchase equity when market value is low.1 Second, analyses of long-run stock returns fol* Baker is from the Harvard University Graduate School of Business Administration. Wurgler is from the New York University Stern School of Business. We thank Arturo Bris, John Campbell, Paul Gompers, Roger Ibbotson, Andrew Roper, Geert Rouwenhorst, Geoff Verter, Ralph Walkling, participants of seminars at Columbia, Cornell, Duke, Harvard, INSEAD, MIT, Northwestern, NYU, Rutgers, Stanford, University of Chicago, University of North Carolina at Chapel Hill, University of Notre Dame, Wharton, and Yale, and especially Richard Green, Andrei Shleifer, Jeremy Stein, Ivo Welch, and an anonymous referee for helpful comments. We thank John Graham and Jay Ritter for data and Alok Kumar for research assistance. Baker gratefully acknowledges the financial support of the Division of Research of the Harvard Graduate School of Business Administration. 1 Seasoned equity issues coincide with high valuations in Taggart (1977), Marsh (1982), Asquith and Mullins (1986), Korajczyk, Lucas, and McDonald (1991), Jung,...
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