The effects of lines of credit on market timing and the underpricing of seasoned equity offerings

Abstract

PurposeThis paper aims to examine the effects of lines of credit on a firm’s market timing behavior and the pricing of its seasoned equity offerings (SEOs). It shows that firms with lines of credit are more likely to time the equity market and receive less underpricing for their SEOs. It also shows that the propensity of firms with lines of credit to time the market is particularly significant for financially unconstrained firms. The results are robust to different measures of market timing and financial constraint, and these fill the gap in the literature that, to the best of the authors’ knowledge, has not examined the relation between lines of credit, market timing and value creation as related to equity offerings.Design/methodology/approachThe paper first investigates the relationship between lines of credit and the probability of a firm issuing SEOs using a logistic model. The paper then investigates whether firms with lines of credit engage in market timing behavior using ordinary least square regressions with two-way cluster-robust standard errors (standard errors that are robust to simultaneous correlation along two dimensions, such as firms and time) with two measures of market timing and two measures for financial constraints. Finally, the paper examines the relationship between lines of credit and SEO underpricing.FindingsIt was found that firms with lines of credit are more likely to time the equity market, perhaps driven by the financing flexibility resulting from the existence of their lines of credit. This finding comes mainly from financially unconstrained firms, as such an effect is not observed among financially constrained firms with lines of credit. It is further shown that firms with lines of credit are more likely to experience less severe equity underpricing, perhaps owing to market timing behavior. The results provide evidence on how lines of credit may create value to a firm through its market timing.Originality/valueThe paper sheds new light on how lines of credit may create value to a firm through the market timing channel.