Valuation errors at the time of security issuance and the market timing theory of capital structure: Valuation errors in equity and the motives for issuing convertible debt

Scope and method of study. The purpose of the study, Valuation Errors at the Time of Security Issuance and the Market Timing Theory of Capital Structure, focuses on the role of equity market timing in the capital structure of the firm. This study contributes to this area of research by examining the public equity vs. public and private debt issuance decision in a framework that incorporates variables that control for the static trade off, pecking order, and market timing theories during the period 1981 to 1999. A logistic regression method is used to predict the likelihood that firms will issue a particular type of security in a multivariate setting.; Findings and conclusions. The results indicate that there is strong evidence for the market timing hypothesis of capital structure. The value of equity at the time of issuance has a strong influence on the security decision choice, but the implications of the static trade off theory and the pecking order theory in this decision choice cannot be ruled out in the study.; Scope and method of study. The purpose of the study, Valuation Errors in Equity and the Motives for Issuing Convertible Debt, is to examine managerial motives behind the issuance of convertible debt securities. This study employs an innovative method using valuation errors in equity at the time of the security decision choice to test the risk-shifting hypothesis, the backdoor equity hypothesis, and the market timing hypothesis of convertible debt. It uses a sample of 408 U.S. non-financial firms issuing convertible debt during the period 1971 to 1998. To test the three hypotheses, the risk neutral probability of conversion is utilized as a metric to bifurcate the sample into firms that substitute convertible debt for straight debt and those that substitute convertible debt for common equity.; Findings and conclusions. The study finds support for the risk-shifting and backdoor equity hypotheses, but provides no evidence for the market timing hypothesis.