A Theory of Capital Structure, Price Impact, and Long-Run Stock Returns under Heterogeneous Beliefs

We study an environment with short sale constraints and heterogeneous beliefs among outsiders and between insiders and outsiders. Firm insiders choose between equity, debt, and convertible debt to raise external financing. We analyze two settings: one where heterogeneous beliefs is the only market imperfection and another where there are significant security issue and financial distress costs. Our model generates a pecking order of external financing different from asymmetric information models, and new predictions for capital structure, sequential tranching of securities, the price impact of security issues, and long-run stock returns. It also provides a new rationale for convertible debt issuance.

Keywords: Capital Structure, Heterogeneous Beliefs, Convertible Debt Issues, Security Tranching, Price Impact, Long-Run Stock Returns.

JEL Classification: G32

Suggested Citation: Suggested Citation

Bayar, Onur and Chemmanur, Thomas J. and Liu, Mark H., A Theory of Capital Structure, Price Impact, and Long-Run Stock Returns under Heterogeneous Beliefs (May 1, 2015). Review of Corporate Finance Studies (RCFS), September 2015, 4 (2), 258-320, Available at SSRN: https://ssrn.com/abstract=1573079 or http://dx.doi.org/10.2139/ssrn.1573079

Onur Bayar

University of Texas at San Antonio - Alvarez College of Business ( email )

The University of Texas at San Antonio
One UTSA Circle
San Antonio, TX 78249
United States
210-458-6837 (Phone)
210-458-6320 (Fax)

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/