External Financing and Future Stock Returns

Topics - Equities

${ numberSection } ${ text }
External Financing and Future Stock Returns

Working paper

In this paper, we provide a comprehensive analysis of the relationship between external financing transactions — equity offerings, debt offerings and bank borrowings — and future stock returns. Previous research has focused on individual categories of financing transactions (common stock issues, debt issues, common stock repurchases etc.). However, firms frequently engage in refinancing transactions that involve little net change in total capital, but simply shuffle capital between different categories (e.g., issuing debt to repurchase equity). These transactions represent potential omitted variables in prior research.

For example, a firm issuing debt to repurchase equity may consider both its debt and equity underpriced, but its equity relatively more underpriced. Under such circumstances, past research would mistakenly classify the issuance of debt as an attempt to exploit the perceived overvaluation of debt. By simultaneously examining all external financing transactions, we provide more powerful tests of the mispricing hypothesis.

Our results provide several new insights. First, we find that our comprehensive measure of net external financing has a stronger relation with future stock returns than the individual categories of financing transactions examined in previous research. Second we show that, after controlling for refinancing transactions, there is a strong and consistent relation between all major categories of external financing and future stock returns. Finally, we show that the predictive ability of net changes in external financing with respect to future stock returns hinges critically on the use of the proceeds.

Taken as a whole, our results suggest that the predictable future stock returns are primarily attributable to overinvestment.

AQR Capital Management, LLC, (“AQR”) provide links to third-party websites only as a convenience, and the inclusion of such links does not imply any endorsement, approval, investigation, verification or monitoring by us of any content or information contained within or accessible from the linked sites. If you choose to visit the linked sites, you do so at your own risk, and you will be subject to such sites' terms of use and privacy policies, over which AQR.com has no control. In no event will AQR be responsible for any information or content within the linked sites or your use of the linked sites.


The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. The views and opinions expressed herein are those of the author and do not necessarily reflect the views of AQR Capital Management, LLC, its affiliates or its employees. This information is not intended to, and does not relate specifically to any investment strategy or product that AQR offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein. Past performance is not a guarantee of future results.


Hypothetical performance results have many inherent limitations, some of which, but not all, are described herein. The hypothetical performance shown was derived from the retroactive application of a model developed with the benefit of hindsight.  Hypothetical performance results are presented for illustrative purposes only.


Diversification does not eliminate the risk of experiencing investment loss.


Certain publications may have been written prior to the author being an employee of AQR.

This material is intended for informational purposes only and should not be construed as legal or tax advice, nor is it intended to replace the advice of a qualified attorney or tax advisor.