How Managers Make Financing Decisions in Dual-Undervalued Markets?

Yusuf Babatunde Adeneye, Ei Yet Chu, Fathyah Hashim


The increasing use of internal equity financing across corporate firms in the world does not support the assertion that securities issuance determines the corporate financing decisions of firms. High internal equity financing is relevant for managerial aversion in financing decisions. This paper investigates a behavioural pattern in financing decisions when equity market is undervalued, and at the same time, firms experience unfavourable or costly debt market. The theoretical assumptions and contextual research with practical data are collected from the World Bank Enterprise Survey. Financing decisions of firms is largely dependent on retained earnings. World Bank Enterprise Survey showed that over less than 15 percent of investments are financed internally by firms across all countries due to undervaluation of equity markets and unfavorable or costly debt markets. Managers maximize the risk in equity financing (risk aversion) and minimize the regret of debt capital (regret aversion) plus the cost of risk reduction in dual undervalued equity and debt markets. The paper reveals that there is evidence of an internal equity persistence among firms. Managers are constrained by the dual undervaluation of equity and debt markets that triggers risk and regret aversion in financing decisions. Managerial aversion (risk and regret aversion) can be used to explain the variations in the corporate financing of firms. Practically, managerial aversion may reduce the risks of external financing i.e. agency problem. Theoretically, managerial aversion follows the assumptions of the regret theory than marketing timing theory in capital structure decisions.

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