The effect of firms’ net financing on stock market performance: Market timing and real investments hypotheses

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Volume Title

School of Business | Master's thesis

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Date

2024

Department

Rahoituksen laitos

Major/Subject

Mcode

Degree programme

Finance

Language

en

Pages

43

Series

Abstract

In this paper, I study whether market timing or investment-based theories can explain the stock market underperformance observed after firms raise external capital. I follow the methodology of Butler et al. (2011) while adding 15 years of data from 2008 to 2023. I also study how the results from the original sample (1975-2007) compares to the more recent sample (2008-2023). When forming portfolios based on the quartile on the external capital raised and testing those with established asset pricing models, namely CAPM, Fama & French 3-factor, and Fama & French 5-factor models, I find that the alphas decrease monotonically from highest with firms raising the least external capital to lowest for firms raising the most external capital. The results hold in the whole sample as well as both subsamples with similar magnitude, but the new and smaller sample does lose a lot of the statistical significance compared to the original sample. When testing whether market timing or investment-based theories could explain these results, I split the data into two groups based on their external financing figures: those with positive and those with negative external capital raised. I then subdivide these groups according to the equity ratio in the capital they raised, distinguishing between firms with an equity ratio greater than 50% and those with an equity ratio less than 50%. I then form portfolios of these groups based on the quartiles of external capital raised. I then test whether I can isolate if the level of external financing (investment-based theory) or the composition (market timing theory) explains the alphas seen in the regression analysis. My results show that, in general, the extreme values of net financing, e.g. the largest external financing in the sample with positive net financing firms have significant negative alpha, and firms with the least net financing, e.g. portfolio with lower NF figure in the sample with negative external financing, has significant and positive alphas. The result hold with CAPM and Fama & French 3-factor model in both subsamples, but the results are generally statistically insignificant in the new and smaller subsample.

Description

Thesis advisor

Puttonen, Vesa

Keywords

capital issues, stock market performance, net equity, net debt

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https://urn.fi/URN:NBN:fi:aalto-202408255627

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[gradu] Kauppakorkeakoulu / BIZ