Understanding the decision of issuing equity in Indian markets

Abstract

One of the most intriguing questions which companies generally face when in need of new finance is whether to raise equity or debt. And, there lies the central question in Corporate finance as to why and when do firms issue equity? There’s been a general consensus that firms issue equity when the stock prices are high, but this is inconsistent with other theories of security issuance and capital structure. The above mentioned theory rests on the simple idea that the manager’s security issuance decision depends on how this decision will affect the firm’s investment choices and how this choice in turn will affect the firm’s post-investment stock price. The manager cares both about the stock price immediately after he invests in the project for which the financing was raised and about the firm’s long-term equity value. The price reaction to this investment decision depends on whether the investors endorse the decision to be a good one or a bad one. To the extent that the manager can anticipate the degree of agreement between what he thinks is a good project and what investors think is a good project, he can form an expectation about. The expectation of the issuance decision lies in how the stock price will react when the firm makes his investment decision indicating that the degree of agreement is central to the manager’s financing choice. Also, since the manager’s objective function is based on the firm’s equity value, there is no perceived divergence between the goals of the manager and its shareholders. The shareholders may object to this investment primarily due to the different beliefs they have about the net present value of the project. We have a three-pronged approach used in our study. First, we test that equity is issued when stock prices are high, by using a sample of around 250 companies who have issued equity/ debt in a given period of 20 years. Second, we examine whether firms with high agreement parameters issue equity regardless of their stock price. We test this prediction by categorizing companies into group affiliated and stand-alone companies. Third, we further discriminate among the different hypotheses by testing whether capital expenditures (CAPEX) increase after equity issues.