Asset growth and equity financing

It is well established that growth in different balance sheet items can be used to predict stocks’ cross-sectional average returns. Early studies in the field (Sloan 1996; Titman et al., 2004; Pontiff & Woodgate 2008) document a negative relationship between the balance sheet items expanding activities of the company and the subsequent company’s stock price performance. However, recent studies support the view that the changes in balance sheet size and the anomalous return patterns are related to a broader asset expansion and contraction phenomenon, rather than to the growth in a single variable in the balance sheet. The present paper examines the impact of interactions of the asset growth effect and equity financing activities on stock returns. We further seek to examine whether the asset growth effect reflects mispricing or it could be attributed to rational risk premia. Our work extends that of Bali et al. (2010) by examining whether equity financing activities can also provide insight into the underlying explanation of the asset growth effect, with the use of UK data from the Thompson Reuters Eikon database. In order to assess our hypothesis of an interaction between the asset growth effect and equity financing activities, we form bivariate portfolios sorted on total asset growth and net equity financing. Under a mispricing-based explanation, abnormal returns should be stronger and more significant in the bivariate portfolio. However, under a risk-based explanation we should not expect any difference in magnitude and significance using a bivariate portfolio reflecting congruence in the signals of total asset growth and net equity financing. To ensure the robustness of our results, we conduct our analysis both at the portfolio level as well at the stock individual level. We incorporate Fama-MacBeth (1973) cross-sectional regressions to assess the predictive power of total asset growth for future stock returns. Finally, the regressions are estimated for the entire sample and separately for sub-samples where total asset growth and net equity financing have concurring and conflicting results on future stock returns.