SEO Timing, the Cost of Equity Capital, and Liquidity Risk

Abstract

This paper uses a simple approach to capture time-varying risks surrounding seasoned equity offerings to shed further light on SEO timing and post-issue underperformance. We find that a steady decline in issuing firms’ cost of equity capital to its lowest point prompts them to file SEOs. The decline is largely due to (1) market-wide improvements in both market risk and liquidity risk, starting about six months prior to SEO filing, and (2) an additional decrease in SEO firms’ liquidity risk just prior to SEO filing. Liquidity risk of SEO firms rebounds but stays relatively low in the filing month, and remains relatively low at issuance and thereafter for two to three years, while their market risk are not significantly different from that of their matched firms. Controlling for the (lower) liquidity risk, along with the market risk, is sufficient to show no post-issue abnormal returns. We also find that the lower liquidity risk allows issuing firms to reduce their offering price discount and mitigate the negative SEO announcement effect. Our findings imply that, instead of exploiting market inefficiency, managers time SEOs by following the improvements in market conditions and in their own stocks’ liquidity environment in order to minimize their firms’ cost of equity capital.