- An Introduction to Capital Structure
- Basic Differences in Capital Structure of Two Firms
- Value of a Firm (Using Operating Free Cash Flows)
- Does Capital Structure Matter?
- Agency Costs of Equity and Debt
- Why Issue of Additional Equity Leads to Share Price Fall?
- What CFOs Consider While Making Capital Structure Decisions?
Why Issue of Additional Equity Leads to Share Price Fall?
It is generally observed that when a firm issues additional equity, the share prices fall. Why does that happen? Since the firm uses equity in value-adding investments, it may surprise people that the stock prices actually fall.
One explanation of this phenomenon can be given by the theory of information asymmetry. According to this concept the management has more information about the prospects of the firm, compared to shareholders, debt-holders and other stakeholders.
We also know that the management issues more equity when the equity value is high.
Since the management knows best, when they issue additional equity, the market interprets that the equity is overvalued. And therefore the stock prices fall.