Empirical evidence suggests that the market price of a firm's existing shares is most likely to decline upon the announcement of a new equity issue. Management will issue equity only when it believes that existing shares are undervalued has been advanced as a possible explanation for this phenomenon.

Question

Quizplus · Accepted Answer

The explanation provided is incorrect; the market price of a firm's existing shares is most likely to decline upon the announcement of a new equity issue because investors often interpret such announcements as a signal that the firm's management believes its shares are overvalued, not undervalued. This is known as the "signaling theory."

Empirical Evidence Suggests That the Market Price of a Firm's