Costly external equity: Implications for asset pricing anomalies

Abstract

We document new evidence that the magnitude of the investment anomaly, the asset growth anomaly, the value premium, and the net stock issues puzzle is higher in financially more constrained firms than that in financially less constrained firms. We interpret the evidence using an investment-based asset pricing model augmented with costly external finance. Intuitively, financial frictions make marginal costs of investment more sensitive to investment in more constrained firms, giving rise to a stronger negative relation between investment and the discount rate.