MANAGING THE COSTS OF ISSUING COMMON EQUITY: THE ROLE OF REGISTRATION CHOICE

Abstract

Introduction Issuing common equity is an expensive way to raise capital. Costs include fees paid to underwriters, downwards price pressure from an increased supply of shares, time delays that uniquely arise from registering equity, and asymmetric-information-related stock-price declines at issuance announcements. These costs can differ, however, depending on the type of equity that firms choose to raise and firm characteristics. For example, Fama and French (2005) argue that some equity issuances, including employee stock options and equity used as currency in mergers, do not suffer from an asymmetric information problem and are therefore less costly than public-equity issuances. Gomes and Phillips (2005) demonstrate that firms with high levels of information asymmetry are more likely to privately place equity than are firms with low information asymmetry. These findings suggest that firms choose low-cost methods to raise capital. In the United States, most firms have a choice of how to register and issue equity through seasoned equity offerings (SEOs). In this paper, controlling for firm and offering characteristics, we test whether firms can lower the costs of raising equity by optimally choosing among Securities and Exchange Commission (SEC) requirements for registering and issuing SEOs. The traditional method requires firms to file registration statements that include detailed disclosure about the firm and the securities being offered for sale in advance of security offerings. This information-intensive procedure, which is designed to mitigate problems of asymmetric information between firms and investors, is time consuming and subject to delays. (1) The second method is a deregulated streamlined process called unallocated shelf registration (which we refer to throughout the remainder of the paper as shelf). Shelf permits firms to file a single all-encompassing registration statement once every two years rather than filing individual registration statements for every security offering. A shelf simultaneously registers many types of potential security offerings, including debt and common equity, which a firm may issue at its discretion over the succeeding two years. Firms register securities without specifying the amount of each security to be offered, the expected timing of offerings or, importantly, the expected use of the proceeds. Once registration statements are approved by the SEC, firms face no additional disclosure requirements or regulatory delays when issuing securities. Compared to the traditional registration procedure, shelf contains few features to mitigate information asymmetry between firms and investors. Shelf offers users increased flexibility in the timing of securities sales and design. Accessing the market quickly allows firms to fulfill capital immediacy needs and take advantage of windows of opportunity in the market (Bayless and Chaplinsky, 1996). Proponents also argue that shelf promotes underwriter competition, lowering direct issuance costs, relative to traditional registration. The design of shelf registration trades off maximizing shareholder welfare in terms of asymmetric information and minimizing firm-specific issuance costs. Using a sample of SEOs between 1992 and 2002, we examine the types of firms that choose each registration strategy and compare the costs that firms incur. Although all of the firms we examine are eligible to use both shelf and traditional registration, we find firms that choose shelf are larger, more highly levered, and more widely followed by analysts than are firms that use traditional registration. After controlling for selection effects, we find firms that use shelf access the market significantly faster than firms that use traditional registration. The underwriting spread for shelf common equity issuances is significantly lower than for traditional SEOs. Thus, shelf lowers the cost of raising equity relative to traditional registration. …