Do Stock Prices Underreact to Seo Announcements? Evidence from Seo Valuation

Abstract

This paper examines whether the market underreacts to the negative information implicit in the SEO (seasoned equity offerings) announcements. While rational and mispricing theories both predict SEO's, in the aggregate, should earn low returns in the long run, they offer sharply different predictions for the cross-sectional relationship between pre-SEO valuation and long-run returns. We find that SEOs that are more overvalued (relative to their non-issuing industry peers) prior to the announcement day experience the same rate of decline in market value as SEOs that are less overvalued but experience a significantly larger decline over the subsequent five years. These results are consistent with the underreaction hypothesis and inconsistent with solely risk-based explanations. Our cross-sectional findings are robust to controlling for capital investments, expected growth rates, accruals, leverage, percentage shares issued in the SEO, pre-SEO price run-up, and B/M ratios. Additional tests indicate that overvalued SEOs earn lower returns around future quarterly earnings announcements and do not exhibit superior ex-post operating performance. We argue that both risk and mispricing theories are needed to fully understand the evolution of SEO fundamentals and stock prices over time.