Managerial market timing refers to a manager’s actions which directly intend to capitalize on a temporary mispricing of a security, in particular through issuing overvalued securities and repurchasing undervalued securities. In terms of the debt market, it refers to any debt issuance associated with market conditions which suggests a low cost of capitalization. A number of survey studies (e.g. Graham and Harvey (2001) and Bancel and Mottoo (2004)) discover that managers attempt to time the debt market during their debt issuance decisions and pick opportune moments, notably when interest rates are particularly low. Furthermore, there have also been a number of empirical studies which have examined the true ability of firms to time the debt markets. Baker et al. (2003) document that, at the market level, the long-term share of aggregate debt issuance once correlated to yield curve movements, can predict the excess returns of the debt market.
Faulkender (2005) examines corporate debt issuance from the perspective of risk management, and indicates that the yield type choices of corporate debt issuance are also driven by debt market variables, and therefore firms time the market in order to lower the capital costs they face rather than hedging the interest exposure. However, the underlying implications are not as straightforward as the conclusions seemingly indicate. Actually, the evidence regarding managers’ ability to time the market in a stream of literature remains mixed. The majority of supportive evidence comes from the identification of the relationship between the firm’s debt issue decisions and debt market condition factors (Barclay and Smith (1995), Stohs and Mauer (1996), Guedes and Opler (1996), Datta et al (2000) and Baker et al. (2003), among others).
On the other hand, contradictory evidence arises from studies based upon the efficient market hypothesis, such as Schultz (2003), Butler et al. (2005, 2006) and Barry et al. (2008). Besides, Brown et al. (2006), and Adam and Fernando (2005), argue that managers’ timing behaviour does not add value to firms, which implies unsuccessful market timing. A very important reason for the mixed evidence is the plausible notion that firm managers make financing decisions corresponding to the variations of market conditions, which contains a multitude of implications.
As suggested by Butler et al. (2006), some of these results suggest forward-looking market timing, i.e. decisions are made based on the prediction of future market variations, while others can be defined as backward-looking market timing, which implies the reactions to prior and current market conditions. The mixture of these different definitions, to a large extent, explains why there still remains much debate among empirical studies regarding this the validity of managerial market timing. Therefore, it is important to empirically clarify the different implications of the managers’ ability to predict future market variations and their responses to the changes in market conditions.
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Market Timing of Corporate Debt Issuance: Prediction or Reaction?
