Implied Volatility and Flotation Costs of SEOs

Abstract

The structure of a firm-commitment Seasoned Equity Offering (SEO) resembles a put option underwritten by an investment bank syndicate. Employing implied volatilities from issuers’ stock options as a direct forward-looking measure, this paper examines the impact of expected price risk on the direct cost of issuing equity. Using a comprehensive sample of 1,208 SEOs between 1996 and 2009, we find issuers with higher option implied volatilities raise less external equity capital and pay higher total investment bank fees in the stock market, ceteris paribus. The effect of implied volatility on the investment bank fees is incremental to the previously documented factors, stronger for larger issuers with lower pre-SEO realized stock volatilities, and for SEOs with higher expected price pressures around issue dates. These relationships are robust to adjustments for correlations among control variables, sample selection bias and also simultaneous determination of offer size and SEO fees.