August 2013

Equity Market Misvaluation, Financing, and Investment

Missaka Warusawitharana and Toni M. Whited


We quantify how much nonfundamental movements in stock prices affect firm decisions. We estimate a dynamic investment model in which firms can finance with equity or cash (net of debt). Misvaluation affects equity values, and firms optimally issue and repurchase overvalued and undervalued shares. The funds owing to and from these activities come from either investment, dividends, or net cash. The model fits a broad set of data moments in large heterogeneous samples and across industries. Firms respond to misvaluation by adjusting financing more than by adjusting investment. Managers' rational responses to misvaluation increase shareholder value by up to 8%.

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Keywords: Market-timing, investment, saving

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Last Update: June 26, 2020