The Underreaction Hypothesis and the New Issue Puzzle: Evidence from Japan

Abstract

This paper investigates the long-term performance of Japanese firms issuing convertible debt and equity. We examine a wide range of types of issues: private issues, public issues, offshore issues, and rights issues. We find the issuing firms perform poorly (except for equity rights issues) even though the stock-price reaction to convertible debt and equity issue announcements is not significantly negative for Japanese firms. This underperformance is strongest for firms issuing public convertible debt in Japan. Though in the U.S. underperformance appears to be concentrated in the smaller firms and in the firms with a high market-to-book ratio, this is not the case in Japan. Simple behavioral explanations for the underperformance of U.S. equity issuing firms do not seem consistent with the Japanese experience, but both countries fit a story where investors and managers are too optimistic about the investment opportunities of some firms.