Market Timing and Cost of Capital of the Firm

Graham and Harveys (2001) survey evidence and Baker, Greenwood, and Wurgler (2003) indicate that firm managers try to time debt markets based on term spreads or excess bond returns when choosing the maturity of new debt issues. Whether debt market timing increases firm value via a reduced cost of capital is an empirical question. I examine differences in firm value across non-timers and timers, where timers are defined as firms that follow either a naïve strategy of choosing long-term debt when the term premium is low or a complex strategy from Baker et al. (2003) based on the predictability of future excess bond returns. Also, I combine a debt maturity function and a complex timing strategy to obtain a better classification of timers. Timers are assumed to choose different maturity from the predictions of the debt maturity function to follow a complex strategy.First, I investigate whether the timing strategies affect the share price response to announcements of straight debt offerings. I find no evidence that timing strategies affect share price responses to announcements of debt offering. Second, I investigate whether timers have higher firm value than non-timers, as measured by Tobins q. After controlling for various determinants of firm value, I find no differences in firm value between them. Third, I investigate whether firm value for timers increases more than that for non-timers after the debt issues. I find no differences in changes in value between them.In addition, I consider that firms could have private information about their future credit quality and use the information to time debt markets. Timers issue short-term (long-term) debt when they expect increases (decreases) in credit quality. I find that timers have lower firm value than non-timers. This result is consistent with previous findings that bond ratings changes follow financial and operational abnormal performance, and thus investors are able to predict bond ratings changes. Overall, although firms apparently try to time debt markets using market interest rates or future credit quality, they fail to increase firm value. The results suggest that corporate debt markets are efficient and well integrated with equity markets.