Equity Market Accounting Theory

Equity market timing is one of the most important factors that influence corporate financing decisions. Several evidences show that the firms prefer to use equity capital when their market values are high, relative to the book values, and to repurchase equity at the time when their market values are relatively low. With the publication of Baker and Wurgler’s research on the capital structure of U.S. non-financial firms, the market timing theory challenges the traditional capital structure theories and brings out a new explanation of the observed capital structure of non-financial firms. They suggest that “the capital structure is the cumulative outcome of past attempts to time the equity markets.”[ See Baker and Wurgler (2002), p. 1] The question

publicly traded non-financial firms and Gropp and Heider (2010) in large U.S. and European commercial banks, and answer the following questions: What determines U.S. publicly traded bank’s financing decisions? Is there any similarity between banks’ and non-financial firms’ determinants of capital structures? What is the impact of market timing on the bank’s capital structure? Is this impact persistent or temporary?

The main findings are that the banks, who have raised funds when their market valuations were high, have lower current leverage ratio. This confirms Baker and Wurgler (2002) results that the historical market valuation has a large, negative and persistent impact on bank’s capital structure. The effect of past market valuation is stronger than the effect of current investment opportunities, which is measured by the market-to-book ratio. The results are inconsistent with the traditional capital structure theories, but provide support for the market timing

Section 2 reviews the relevant theoretical literature about capital structure and market timing theory. Section 3 describes my sample and main methodology used in this paper. Section 4 presents the determinants of annual change in banks’ capital structure and tests the channel through which they affect the financing decision of banks. Section 5 analyses the effect of historical market valuation on the banks’ capital choices. Section 6 examines the persistence of the impact of market valuation on banks’ liabilities. In Section 7, I discuss the results and try to find explanations with the existing theories of bank capital structure. Finally, Section 8 concludes the