Why isn't composite equity issuance favored by the stock market? A risk-based explanation for the anomaly

Abstract

Composite equity issuance anomaly is puzzling. This study presents a risk-based explanation that complements and transcends the behavior-based explanation by prior mainstream literature. Investors react to the signal embedded in the composite equity issuance and adjust a firm's risk level through implied cost of equity capital, which leads to lower subsequent stock returns. Empirical results show that firms with higher composite equity issuance are associated with more expensive equity financing. This positive effect remains solid after addressing potential endogeneity and is robust to individual and alternative measures of implied cost of equity capital. Moreover, further evidence demonstrates the role of agency problem for both internal and external factors. The positive effect is more pronounced for firms with less independent and diversified boards, lower financial reporting quality and leverage, higher R&D spending, in a non-competitive environment, and during a financial crisis respectively.