Evidence on the Tradeoff Between Risk and Return for Ipo and Seo Firms

Abstract

Do the low long-run average returns of equity issuers reflect Do the low long-run average returns of equity issuers reflect underperformance due to mispricing or the risk characteristics of the issuing firms? We shed new light on this question by examining how institutional lenders price loans of equity-issuing firms. We find that equity-issuing firms' expected debt return is equivalent to the expected debt return of non-issuing firms with similar characteristics, implying that institutional lenders perceive equity issuers to be as risky as similar non-issuing firms. We also find that institutional lenders perceive small and high book-to-market borrowers as systematically riskier than larger borrowers with low book-to-market ratios, consistent with the asset pricing approach in Fama and French (1993). Finally, we find that firms' expected debt returns decline after equity offerings, consistent with recent theoretical arguments suggesting that firm risk should decline following an equity offering if equity is issued to exercise a real option. Overall, our analysis provides novel evidence consistent with risk-based explanations for the observed equity returns following IPOs and SEOs.