Impact of heterogeneous beliefs and short sale constraints on security issuance decisions

Extant literatures discuss a firm's security issuance implications of heterogeneous beliefs with explicit assumption that short selling is forbidden. However, it is widely accepted that short sale constraints exist when investors are unable to short stock to the extent they desire. This paper presents a model to analyze how heterogeneous beliefs and short sale constraint conditions jointly affect a firm's security issuance decision. The main findings are: i) An increase in heterogeneity in investors' beliefs results in an increased likelihood of equity issuance over debt when public signal is favorable, whereas it results in a reduced likelihood when public signal is modestly adverse. ii) The tightness of short sale constraints has a positive effect on the likelihood of equity issuance only when public signal is highly favorable. These results indicate widely divergent conclusions about the relations between heterogeneous beliefs as well as short sale constraints and security issuance decision.