Abstract: By relaxing the explicit assumption that short selling is forbidden, a model is presented in this paper to analyzes how heterogeneous beliefs stemming from investors’ overconfidence and short sale constraints jointly affect a firm’s security issuance decision. The main findings are: (1) an increase in heterogeneity in investors’ beliefs results in an increased likelihood of equity issuance over debt when public signal about the project’s payoff is favorable, whereas it results in a reduced likelihood when public signal is modestly adverse. (2) the tightness of short sale constraints has a positive effect on the likelihood of equity issuance only when public signal is highly favorable. These results indicate that the relations between heterogeneous beliefs as well as short sale constraints and security issuance decision are influenced by public signal.

Key words: heterogeneous beliefs, short sale constraints, security issuance