Ch. 4: Behavioral Corporate Finance 163
37%. There is also a suggestion that the riskiest firms may be timing their idiosyncratic
credit quality, despite the survey answers on this point: the shares of unrated issuers have
a median five-year underperformance of 54%. If the equity did so poorly, the debt issues
presumably also did poorly. In a much broader panel,Richardson and Sloan (2003)also
find that net debt issuance is followed by low stock returns.
There are several potential explanations for this pattern. Certainly, equity overvalua-
tion would be expected to lower the cost of debt directly—credit risk models routinely
include stock market capitalization as an input—so the relationship with subsequent
stock returns may reflect debt market timingper se. Or, managerial and investor sen-
timent is correlated; managers may tend to be most optimistic precisely when capital
is cheap, and thus raise and invest as much as they can from any source. This story
combines investor and managerial irrationality and so does not fit neatly within our
taxonomy, but seems like a promising approach for future work. A third possibility, out-
lined inBaker, Stein, and Wurgler (2003), is that equity overvaluation relaxes a binding
leverage constraint, creating debt capacity that subsequently gets used up. But debt is
always correctly priced in this setting, so debt market timingper seis not possible.
2.4.4. Cross-border issues
The evidence inFroot and Dabora (1999)suggests that relative mispricings across inter-
national securities markets are possible, even between particularly liquid markets such
as the US and the UK. This raises the possibility of international market timing. Along
these lines,Graham and Harvey (2001)find that among US CFOs who have considered
raising debt abroad, 44% implicitly dismissed covered interest parity in replying that
lower foreign interest rates were an important or very important consideration in their
decision.^13
In practice, most international stock and bond issues are made on the US and UK
markets.Henderson, Jegadeesh, and Weisbach (2006)find that when total foreign is-
sues in the US or the UK are high, relative to respective GDP, subsequent returns on
those markets tend to be low, particularly in comparison to the returns on issuers’ own
markets. In a similar vein, and consistent with the survey evidence mentioned above,
foreign firms tend to issue more debt in the US and the UK when rates there are low
relative to domestic rates.
2.4.5. Capital structure
As an accounting identity, every firm’s capital structure is the cumulative outcome of
a long series of incremental financing decisions, each driven by the need to fund some
investment project, consummate a merger, or achieve some other purpose. To the ex-
tent that market timing is a determinant of any of these incremental financing decisions,
(^13) Almost all equity raised by US corporations is placed in domestic markets, so Graham and Harvey do not
ask about the determinants of international stock issues.