Financial Announcements Research Articles

Insider trading, growth opportunities and the market reaction to new financing announcements*

The paper examines three hypotheses about the effect of insider trading on the market response to new financing announcements (NFAs) using a sample of disclosures made by UK firms between 1989 and 1991. The study demonstrates first that no systematic relationships exist between the market response to NFAs and pre-announcement insider trading. Second, contrary to the predictions of John and Mishra (1990), the values of growth indicators do not differ significantly between firms that are subject to insider buying and selling prior to NFAs. Third, while there is some evidence to suggest that insider trading and growth prospects influence the market reaction to debt issue announcements, the evidence is not pervasive across growth measures and does not extend to equity issues. This final result helps to resolve an apparent contradiction between the signalling models of John and Mishra (1990), and John and Lang (1991), and suggests that prior studies of the market reaction to NFAs are not significantly flawed by their failure to consider the signalling role of pre-announcement insider trading. The findings are also shown to be relevant to the current debate about whether, and how, insider trading regulations should be tightened. *It is greatly regretted that Mr. Alasdair Lonie, sometime Senior Lecturer in the Department, died while this paper was in review.

Asymmetric Information, Asset Allocation, and Debt Financing

We analyze a signaling game where firms' financing announcements convey private information about their prospects but a moral hazard problem exists in that managers may suboptimally invest. Consequently, the attempt to address an asymmetric information problem exacerbates moral hazard. The equilibrium recognizes both imperfect information problems. Additionally, the firm must determine how to allocate funds between two technologies differing in cash flow timing and managerial accessibility. We define an above-average firm's comparative advantage as that technology which is most dominant relative to a firm with lesser prospects and show that the resultant equilibria follow the lines of the firm's comparative advantage. Finally, we show that separation may be achieved costlessly, i.e., with no explicit signaling cost.

The Wealth Effects of Bank Financing Announcements in Highly Leveraged Transactions

We analyze the effect of financing announcements of highly leveraged transactions (HLTs) on the stock prices of the banks that lead HLT-lending syndicates. Our sample of HLT financing announcements consists of 29 leveraged buyouts and 12 leveraged recapitalizations representing 76 bank financing announcements over the 1983-1989 period. We find that (i) the first HLT announcement and the first bank financing announcement result in positive wealth effects for the banks playing a major role in the loan syndication; (ii) bank wealth effects are lower after 1984 and for smaller HLTs; (iii) bank stock price reactions at the announcement of the HLT and its financing do not provide evidence that the market anticipates which HLTs will eventually fail. Together, our results cast doubt on the conjecture that HLT loans have undermined the interests of bank shareholders. Additionally, we find that LBO targets gain about 2%, whereas leveraged recap targets lose about 2% when the bank financing agreement is announced.

The Wealth Effects of Bank Financing Announcements in Highly Leveraged Transactions

ABSTRACTWe analyze the effect of financing announcements of highly leveraged transactions (HLTs) on the stock prices of the banks that lead HLT‐lending syndicates. For our sample of 41 HLTs, we document that the first HLT and bank financing announcements result in positive wealth effects for the lending banks. We also find that these wealth effects are lower in 1985, for smaller HLTs, and for banks with a high loan loss reserve to total asset ratio. Finally, we report that Leveraged Buyout (LBO) targets gain about 2 percent, whereas leveraged recap targets lose about 2 percent, when the first bank financing agreement is announced.

Corporate growth and the equity-debt choice

In this paper we extend the analysis of earlier investigations into the relationship between patterns of corporate growth and the announcement of new financing (see for example, Pilotte 1992; Burton et al., 1993) by examining the growth in turnover and earnings achieved by equity and debt-issuing firms. We study the performance of UK firms which made new financing announcements between 1989 and 1991 and find (i) that corporate growth generally declined in the years which followed the announcement date and (ii) that equity-issuing firms exhibited higher pre-announcement growth in sales turnover and in earnings than their debt-issuing counterparts – significantly higher growth in the case of the expansion in the value of sales.

Relative information asymmetry as a determinant of the market reaction to corporate financing announcements

Information-asymmetry-based models predict that the market should react negatively to unanticipated external financing. Previous empirical studies lend limited support to these conjectures. This study examines the anticipation issue using financial analysts' earnings-forecast errors as a proxy for information available prior to the external-financing announcement. The conjecture is that external financing would be less anticipated for firms which financial analysts cannot accurately predict their earnings. Event study results indicate that high-prediction-error firms exhibit significantly lower announcement period returns than lowprediction-error firms for non-convertible debt, convertible debt, and common stock offerings.

Contractual Resolution of Bondholder-Stockholder Conflicts in Leveraged Buyouts

L EGAL scholars and economists have long recognized that the interests of stockholders and bondholders often conflict. Since bondholders own fixed claims that are senior to the residual and limited liability claims of stockholders, the two classes of security holders often differ over corporate policies, including policies about cash distributions to stockholders, the issuance of additional debt, and the riskiness of investment projects.' Although bondholder-stockholder conflicts have been the source of much litigation during this century, U.S. courts generally have maintained that these conflicts should be resolved explicitly in bond contracts. For example, in 1981 in Broad v. Rockwell International Corp.,2 a federal court stated that it "will not rewrite a term of a [bond] contract by interpretation when that term is clear and unambiguous on its face." In Katz v. Oak Industries3 the Delaware Court of Chancery restated the common-law tradition: "Arrangements among a corporation, the under-

EQUITY VALUATION EFFECTS OF WARRANT‐DEBT FINANCING

AbstractStock price reactions to warrant‐debt unit financing announcements are examined and a significant two‐day average abnormal return of −1.32 percent is found. The negative average abnormal return is similar to that observed for convertible debt financing announcements in previous research. Warrant‐debt financing decisions result in large increases in capitalization; on average, issuers' long‐term debt increases by 84 percent, and common shares outstanding increase by 18 percent assuming full exercise of the warrants.

Corporate Earnings and Financings: An Empirical Analysis

This article examines the long-term behavior of corporate earnings around three corporate financing events: sales of common stock, convertible bonds, and straight bonds. The article shows that earnings declined for all issuers and that more capital is raised the larger the earnings decline. These findings indicate that external financings are motivated by earnings declines. No evidence is found of a relationship between the size of the subsequent earnings downturn or the amount of capital raised and stock price reactions to the financing announcements. These findings suggest that security sales did not systematically provide new information about either the magnitude of subsequent earnings downturn or the amount of financing. Copyright 1990 by the University of Chicago.

Deficit financing announcements and asset prices

There is a growing literature on the effect of economic news on asset prices. The effects of weekly money supply announcements on interest rates have been empirically investigated by a number of researchers over a variety of periods (Cornell 1982; 1983a; 1983b, Roley 1982; 1983, Roley and Walsh 1984, Urich and Wachtel 1984, Hein 1985, Gavin and Karamouzis 1986). The response of foreign exchange rates to new economic information has also been studied (Dornbush 1980, Frenkel 1981, Edwards 1982, Engle and Frankel 1984, Hardouvelis 1984, Hakkio and Pearce 1985, Culbertson and Koray 1986), while Cammack (1987) has studied the response to information in Treasury bill auction markets. Most recently, Wachtel and Young (1987) have studied the response of various interest rates to the Office of Management Budget and Congressional Budget Office projections of current and future Federal government deficits. Although a reading of the financial press would suggest that the Treasury's quarterly debt financing announcements are an important type of news for financial market participants, the examination of market responses to this type of news has not been investigated. The purpose of the present study is to investigate the financial market response to these announcements, and to relate these results to other studies of market response to economic news. The theoretical model underlying most of the existing news studies assumes that asset prices, including exchange rates, respond only to new information in an efficient market. The effect of this new information on prices is dependent on how the news changes financial market participants' expectations. This expectations effect can vary over time periods, since it is conditioned by market participants' recent experiences and the anticipated response of policymakers to economic news. This paper examines the shortrun responses of several major exchange rates and three types of domestic interest rates to the news implicit in the Treasury's quarterly announcements of new long-term debt issues over the period beginning in the third quarter of 1975 and ending in the third quarter of 1985. The time horizon is long enough to cover the majority of the recent period of floating exchange rates, as well as encompassing the period since the early 1980s, when the financial press became particularly concerned with the magnitude of the Federal deficit and its impact on financial markets. 1

Information Aggregation, Inflation, and the Pricing of Indexed Bonds

Using daily prices of indexed bonds between 1970 and 1979, we test whether announcements of the Israeli CPI contain information that is not already reflected in bond prices. The results indicate that bond prices reflect about 85 percent of the new information about inflation as it occurs (i.e., when the Central Bureau of Statistics samples prices). The announcement of the CPI 15 days after the end of the sampling period causes the remaining 15 percent adjustment in bond prices. This evidence raises questions about the empirical importance of misperceptions about inflation as a source of nonneutrality in monetary policy.

External Financing and Liquidity

ABSTRACTWe explain the observed negative relation between market value of firms and their fund raising activities. Ours is not a signalling model. The firm's objective is to maximize the present value of its income. Considerations of cash availability (liquidity) and unfolding of uncertainty drive our model. Income from operations is an important source of liquidity. Low earnings are associated with low liquidity. Whether earnings are low or not is known to some extent in advance of the realization itself. External financing is pursued in anticipation of the earnings' realization in order to maintain a desired level of liquidity. Therefore, anticipated low earnings are associated with a high level of external financing. Of course, an anticipation of low earnings is also accompanied by a decrease in the firm's value. The empiricist who looks at time series of a firm's value and of its dividend/external financing announcements would then record positive correlation between value and cash distributions and negative correlation between value and external financing.