A Valuation-Based Test of Market Timing

Posted: 19 Feb 2015

See all articles by William B. Elliott

William B. Elliott

John Carroll University

Johanna Koëter-Kant

VU University Amsterdam

Richard S. Warr

North Carolina State University

Date Written: March 1, 2007

Abstract

We implement an earnings-based fundamental valuation model to test the impact of market timing on the firm's method of funding the financing deficit. We argue that our valuation metric provides a superior measure of equity misvaluation because it avoids multiple interpretation problems faced by the market-to-book ratio. It also eliminates the need to infer market timing based on the actions of corporate insiders or other indirect measures. We find a strong positive relation between the degree to which a firm is overvalued and the proportion of the firm's financing deficit that is funded with equity. This result is found cross-sectionally and through time and is robust to firm size, and other variables known to impact capital structure. We find evidence that overvaluation in the 1990s led to equity being increasingly preferred over debt. For a broad set of firms, market timing explains a significant portion of the variation in the type of security used to fund the financing deficit.

Keywords: Residual income model; Capital structure; Market timing; Financing deficit

JEL Classification: G30; G32

Suggested Citation

Elliott, William B. and Koëter-Kant, Johanna and Warr, Richard S., A Valuation-Based Test of Market Timing (March 1, 2007). Journal of Corporate Finance, Vol. 13, No. 1, 2007, Available at SSRN: https://ssrn.com/abstract=2566530

William B. Elliott (Contact Author)

John Carroll University ( email )

University Heights, OH 44118
United States

Johanna Koëter-Kant

VU University Amsterdam ( email )

De Boelelaan 1105
Amsterdam, 1081HV
Netherlands

Richard S. Warr

North Carolina State University ( email )

BOX 7229
Raleigh, NC 27695-7229
United States
919-513-4646 (Phone)
919-515-6943 (Fax)

HOME PAGE: http://www4.ncsu.edu/~rswarr/

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