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find such evidence. Polk and Sapienza also show that this impact
is greater for shorter managerial horizons, as happens when share
turnover is higher. Following Stein (1996), Baker et al. (2003) study
whether investment will be most sensitive to mispricing for equity-
dependent firms, the case discussed above where e
Baker et al. point out that open questions remain about the mag-
nitude of the mispricing-investment effect and the associated efficiency
implications. In this last respect, Polk and Sapienza (2004) find that in
the cross-section, firms that invest more earn lower subsequent returns.
Titman et al. (2004) find the same pattern, and Lamont (2000) reports
something similar in a time series analysis. Nevertheless, Baker et al.
do not view these results as strong evidence of inefficiency in an ex ante
sense, and claim not to be convinced that the pattern stems from cater-
ing.
Managers might use mergers and acquisitions to cater to investor
sentiment, perhaps by using the overvalued stock of their own firms
to acquire less overvalued targets, or by engaging in a combination
for which sentiment is positive, see Shleifer and Vishny (2003). This
theory offers some insight into the time-series relationship between
merger volume and stock prices. It also explains why cash acquirers
subsequently outperform stock acquirers (who earn negative long-run
returns), see Loughran and Vijh (1997) and Rau and Vermaelen (1998).
2.3 Baker et al. (2007): Survey of Corporate Finance 31
Evidence of a positive correlation between market-level mispricing and
merger volume can be found in Dong et al. (2003), and Ang and Cheng
(2009). These studies report that undervalued targets are more likely
to be hostile to acquisition, and that overpriced acquirers tend to pay
higher takeover premiums. Moreover, subsequent returns to mergers
conducted during high-valuation periods tend to be poor (Bouwman
et al., 2009).
Baker et al. pose an interesting question about mispricing-driven
mergers: why would an overvalued firm use a merger instead of issuing
more equity? They suggest a framing-based explanation that a merger
might be more effective at hiding the underlying misvaluation. Baker
et al. (2004) also propose that investors might respond more passively
to accepting the acquirer s shares as part of the merger (a form of status
quo bias), but would not actively purchase those shares when issued
directly.
An issue related to mergers and acquisition is the diversification
discount. Although there is little in the behavioral finance literature
dealing with this issue, Baker et al. suggest that the 1960 s conglomer-
ate wave reflected a desire by managers to cater to investors preference
for conglomerates. They discuss the work of Klein (2001) who finds a
diversification premium of 36 percent in the period 1966 1968, followed
by a decline between July 1968 and June 1970, as reported in Raven-
scraft and Scherer (1987).
Empirical Studies Involving Financial Policy
As was mentioned in the theoretical section above, mispricing can lead
a firm s managers to engage in market timing, for example by issuing
new shares when equity is overpriced and by repurchasing shares when
equity is underpriced. Survey evidence presented by Graham and Har-
vey (2001) indicates that financial managers view such market timing
activities as very important. Jenter (2005) presents related evidence
that managers conduct secondary equity offerings (SEOs) while simul-
taneously engaging in insider selling.
There is considerable empirical evidence suggesting market tim-
ing in respect to equity. Loughran et al. (1994) report a high positive
32 Survey of Surveys
correlation between volume of initial public offerings (IPOs) and inter-
national stock market valuations. As for seasoned equity offerings
(SEOs), Marsh (1982) reports that equity issuance increases after
recent stock market appreciation. Loughran and Ritter (1995) provide
evidence suggesting the presence of mispricing. Relative to a size-
matched firm, after five years the average IPO underperforms its non-
IPO peer by 30 percent. After reviewing the relevant literature, Baker
et al. conclude that on average U.S. firms issuing equity subsequently
underperform the market by between 20 and 40 percent over five years.
At the same time, they also point out that the equity market timing
issue is controversial, and is still a subject of considerable debate.
In terms of share repurchases, Brav et al. (2005) report survey
evidence indicating that the great majority of firms agree that they
repurchase shares when they view their shares as underpriced in the
market. Indeed, Ikenberry et al. (1995) find that the average repur-
chaser outperformed firms matched by size and book-to-market equity
by 12 percent over the subsequent four years. See also Ikenberry et al.
(2000). Dichev (2004) reports that firms who engaged in market timing
reduced their cost of capital by 1.3 percent a year.
Moving from equity to debt, the survey evidence presented by Gra-
ham and Harvey (2001) does indicate that firms issue debt when they
feel that interest rates are low. Moreover, firms tend to issue short-term
debt when the yield curve is steep, and when waiting for long-term
rates to fall. Marsh (1982) reports that in his sample of U.K. firms, [ Pobierz całość w formacie PDF ]