The effects of overvalued equity to firms' financing choice: Evidence from the UK

Abstract

Purpose of the study The objective of this thesis is to study the effects of equity overvaluation to firms` financing decisions. Specifically, the key focus of this thesis is to study whether overvaluation leads to increased equity and total issuance. Furthermore, I study whether particular firm characteristics increase the issuance sensitivity to misvaluation.

Data and methodology The dataset used in this study includes 7863 firm-year observations from listed companies in the UK. I use value-to-price ratio obtained using residual income model with analyst forecast as my main proxy for misvaluation. I test the relation between misvaluation and security issuance by cross-sectional tests and multivariate regressions for the full sample. Furthermore, I run subsample multivariate regressions sorted by different firm characteristics in order to test issuance sensitivity to misvaluation.

Results My findings show that overvaluation leads to increased equity and total issuance, thus showing proof of managerial ability to take advantage of market inefficiency, and that financial markets have real-world impacts on managerial decision-making. However, I find only weak evidence of catering impacting financing decisions in the UK.