The perception (Nguyen, 2012). According to Baker and

seminal work of Baker and Wurgler (2002) sheds a new light on the capital
structure issue. The authors suggest that it is hard to explain the choice of
financing within the traditional theories. Instead, based on the empirical
findings of the windows-of-opportunities hypothesis, they propose the market
timing theory, which states that capital structure evolves as the cumulative
outcome of past attempts to time the equity market. Firms will choose to issue
equity when their stocks have high market values relative to their book and
past market value. This lowers the firm’s cost of equity and benefits current
shareholders at the expense of new shareholders. On the other hand, firms will
conduct share repurchase in case their stocks are undervalued. When both debt
and equity markets are unusually favorable, managers will raise funds even
though firm has no need for financing currently. Conversely, in case both
markets are unfavorable, firms will defer issuances. This theory also states
that market timing of equity issues have a very large and persistent impacts on
leverage ratio. In particular, temporarily fluctuations in market values cause
permanent changes in firms’ capital structure (Nguyen, 2012).

are two versions of the market timing theory. The first one comes from a
dynamic model of Myers and Majluf (1984), which assumes that managers and
investors are rational and adverse selection varies across firms or over time.
Firms are supposed to issue equity immediately after positive information is
released which reduces the asymmetric between the managers and shareholders.
The decrease in information asymmetry is related to the increase in stock price
and leads to more equity financing. Thus, firms create their own timing
opportunities. The second version of the market timing theory assumes that
managers and investors are irrational which results in mispricing perception (Nguyen,

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 According to Baker and Wurgler (2002), managers
issue equity when the cost of equity is irrationally low and repurchase equity
when the costs of is believed irrationally high. The second version does not
require that the market is inefficient. In fact, the market can still be
efficient while managers believe they can time the market. Both versions of
market timing hypothesis have the same predictions about the relationship between
firm value and financing decisions. Equity-issuing firms are those with high
market value relative to book values and those that earn positive abnormal
returns prior to raising capital.  To sum
up, according to market timing theory, capital structure decisions are taken
based on capital market conditions. Stock prices and interest rate levels are
driving forces for equity and debt issuance decisions respectively (Nguyen,



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