The Journal of Finance

The Equity Share in New Issues and Aggregate Stock Returns

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00285

Malcolm Baker, Jeffrey Wurgler

The share of equity issues in total new equity and debt issues is a strong predictor of U.S. stock market returns between 1928 and 1997. In particular, firms issue relatively more equity than debt just before periods of low market returns. The equity share in new issues has stable predictive power in both halves of the sample period and after controlling for other known predictors. We do not find support for efficient market explanations of the results. Instead, the fact that the equity share sometimes predicts significantly negative market returns suggests inefficiency and that firms time the market component of their returns when issuing securities.

Investor Sentiment and the Cross‐Section of Stock Returns

Published: 08/03/2006   |   DOI: 10.1111/j.1540-6261.2006.00885.x

MALCOLM BAKER, JEFFREY WURGLER

We study how investor sentiment affects the cross‐section of stock returns. We predict that a wave of investor sentiment has larger effects on securities whose valuations are highly subjective and difficult to arbitrage. Consistent with this prediction, we find that when beginning‐of‐period proxies for sentiment are low, subsequent returns are relatively high for small stocks, young stocks, high volatility stocks, unprofitable stocks, non‐dividend‐paying stocks, extreme growth stocks, and distressed stocks. When sentiment is high, on the other hand, these categories of stock earn relatively low subsequent returns.

A Catering Theory of Dividends

Published: 11/27/2005   |   DOI: 10.1111/j.1540-6261.2004.00658.x

Malcolm Baker, Jeffrey Wurgler

We propose that the decision to pay dividends is driven by prevailing investor demand for dividend payers. Managers cater to investors by paying dividends when investors put a stock price premium on payers, and by not paying when investors prefer nonpayers. To test this prediction, we construct four stock price‐based measures of investor demand for dividend payers. By each measure, nonpayers tend to initiate dividends when demand is high. By some measures, payers tend to omit dividends when demand is low. Further analysis confirms that these results are better explained by catering than other theories of dividends.

Market Timing and Capital Structure

Published: 12/17/2002   |   DOI: 10.1111/1540-6261.00414

Malcolm Baker, Jeffrey Wurgler

It is well known that firms are more likely to issue equity when their market values are high, relative to book and past market values, and to repurchase equity when their market values are low. We document that the resulting effects on capital structure are very persistent. As a consequence, current capital structure is strongly related to historical market values. The results suggest the theory that capital structure is the cumulative outcome of past attempts to time the equity market.

Predicting Returns with Managerial Decision Variables: Is There a Small‐Sample Bias?

Published: 08/03/2006   |   DOI: 10.1111/j.1540-6261.2006.00887.x

MALCOLM BAKER, RYAN TALIAFERRO, JEFFREY WURGLER

Many studies find that aggregate managerial decision variables, such as aggregate equity issuance, predict stock or bond market returns. Recent research argues that these findings may be driven by an aggregate time‐series version of Schultz's (2003, Journal of Finance 58, 483–517) pseudo market‐timing bias. Using standard simulation techniques, we find that the bias is much too small to account for the observed predictive power of the equity share in new issues, corporate investment plans, insider trading, dividend initiations, or the maturity of corporate debt issues.

Catering through Nominal Share Prices

Published: 11/25/2009   |   DOI: 10.1111/j.1540-6261.2009.01511.x

MALCOLM BAKER, ROBIN GREENWOOD, JEFFREY WURGLER

We propose and test a catering theory of nominal stock prices. The theory predicts that when investors place higher valuations on low‐price firms, managers respond by supplying shares at lower price levels, and vice versa. We confirm these predictions in time‐series and firm‐level data using several measures of time‐varying catering incentives. More generally, the results provide unusually clean evidence that catering influences corporate decisions, because the process of targeting nominal share prices is not well explained by alternative theories.