Market timing and the debt-equity choice

We test the market timing theory of capital structure using an earnings-based valuation model that allows us to separate equity mispricing from growth options and time-varying adverse selection; thus avoiding the multiple interpretations of book-to-market ratio. We find that equity market mispricing plays a significant, if not dominant, role in the security choice decision. Our results are robust to the inclusion of proxies for time-varying growth options and alternate methods of measuring misvaluation.Capital structure Market timing Security choice Mispricing Earnings-based valuation Residual income model