Investigating the Effect of Equity Market Timing on Corporate Capital Structure

The market timing theory of capital structure states that firms are more likely to issue equity when their market values are high, relative to their true values. Baker and Wurgler (2002) claim that equity market timing has a significant and long-lasting effect on capital structure. Their study has been criticized on the basis that their misvaluation proxy is biased by information on future growth prospects. This thesis makes use of a proxy for misvaluation based on intrinsic value which is believed to not suffer from such confounding factors. The main interest is in the long-run effect of market timing, however, short-term investigations are also performed. The results do not show evidence for a significant relationship between equity market timing and capital structure in the long and short-run. This work sides with the main line of criticism and suggests that the results of Baker and Wurgler (2002) are indeed driven by information on growth prospect, as opposed to by misvaluation and equity market timing