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Strategic Considerations, the Pecking Order Hypothesis, and Market Reactions to Equity Financing

Published online by Cambridge University Press:  06 April 2009

Abstract

Myers and Majluf (1984) showed that in a world of asymmetric information, managers of overvalued firms issue equity, while managers of undervalued firms use cash, if available. This paper shows that, in a multiperiod world, managers of undervalued firms may find it optimal to issue stock, even though cash is available. Consequently, the market does not interpret all announcements of equity issues as signals of firm overvaluation. The paper also generates predictions regarding the effect of information asymmetry and investment opportunities on i) dividend policy, and ii) the cross-sectional distribution of market reactions when an equity issue is announced.

Type
Research Article
Copyright
Copyright © School of Business Administration, University of Washington 1993

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