Flotation Costs Research Articles

Implied Volatility and Flotation Costs of SEOs

The structure of a firm-commitment Seasoned Equity Offering (SEO) resembles a put option underwritten by an investment bank syndicate. Employing implied volatilities from issuers’ stock options as a direct forward-looking measure, this paper examines the impact of expected price risk on the direct cost of issuing equity. Using a comprehensive sample of 1,208 SEOs between 1996 and 2009, we find issuers with higher option implied volatilities raise less external equity capital and pay higher total investment bank fees in the stock market, ceteris paribus. The effect of implied volatility on the investment bank fees is incremental to the previously documented factors, stronger for larger issuers with lower pre-SEO realized stock volatilities, and for SEOs with higher expected price pressures around issue dates. These relationships are robust to adjustments for correlations among control variables, sample selection bias and also simultaneous determination of offer size and SEO fees.

Accelerated Equity Offers: The Role of Internal and External Certification Mechanisms

We examine the role of internal and external certification mechanisms in the issuance choice of SEOs between accelerated offers and fully marketed offers. Our empirical work supports the view that a firm’s internal corporate governance structure and audit fee are associated with the issuance choice between accelerated and fully marketed offers. Furthermore, we find that after controlling for the self-selection problem, firms paying higher audit fee incur lower flotation costs as measured by gross spreads. Finally, we find a significant positive association between audit fee and the net proceeds raised in SEOs.

Contracting under asymmetric information: Evidence from lockup agreements in seasoned equity offerings

We document the frequent use of lockup agreements in seasoned equity offerings (SEOs) and examine the determinants of their use, duration, and early release. We find that the likelihood of an SEO lockup and its duration are positively related to issuer information asymmetry measures. Lockup duration is negatively related to underwriter spreads and underpricing, indicating that lockups lower expected flotation costs. Lockups are frequently released early following share prices rises. We conclude that lockups represent a contracting solution to asymmetric information and agency problems that plague equity issues by helping to insure SEO quality and deter opportunistic insider trading.

Choice of corporate debt in China: The role of state ownership

We analyze the factors affecting the decisions of Chinese firms to take on debt in the form of either bonds or syndicated loans over the period of 2006–2010. The study reveals the extent to which corporate debt choices are politically or economically driven. We test if central government ownership, flotation costs, asymmetries of information, and renegotiation and liquidation costs influence the choice of debt. We find evidence in favor of the influence of central government ownership on the financing choices of firms because Central State owned firms are more likely to issue bonds and to borrow uniquely on the bond market, rather than tapping both debt markets. Overall, our findings show that financial factors play a much more minor role in corporate debt choices compared to other countries, whereas central government ownership is a key determinant of preference for the bond market.

Corporate Governance and Seasoned Equity Offerings: Offer Methods and Flotation Costs

In this paper, we examine whether there is a relationship between the internal corporate governance of a firm and the method by which seasoned equity offerings are made. Extant research posits the view that firms offering equity securities via shelf offerings suffer from an under-certification problem. This is due to the fact that equity issued under shelf offerings is often offered at short notice giving investment bankers inadequate time to conduct due diligence. The problem of under-certification is further exacerbated in the now widely prevalent accelerated offers method of issuing SEOs. We suggest that firms may self-certify their quality by pursuing high standards of internal corporate governance. Our empirical evidence supports this view. We also examine whether corporate governance quality influences the issuer’s decision to use the accelerated offers method of issuing SEOs. Our empirical evidence supports the view that well-governed firms tend to issue accelerated offers as compared to poorly governed firms. Furthermore, we also examine whether flotation costs are influenced by a firm’s internal corporate governance. We find that flotation costs are significantly lower for firms with good governance after controlling for other determinants of flotation costs. We find that audit fee and the use of big4 auditor serve as alternate certification devices. Of the different components of internal corporate governance studied, board composition and effectiveness is most robust to the inclusion of alternate certification devices. It appears that good governance facilitates speedy capital raising and reduces flotation costs. Our findings are potentially useful to corporate managers, investment bankers and regulators.

Bank Capital, Liquid Reserves, and Insolvency Risk

We develop a dynamic model of banking to assess the effects of liquidity and leverage requirements on banks' insolvency risk. In this model, banks face taxation, flotation costs of securities, and default costs and maximize shareholder value by making their financing, liquid asset holdings, and default decisions in response to these frictions as well as regulatory requirements. Our analytic characterization of the bank policy choices shows that imposing solely liquidity requirements leads to lower bank losses in default at the cost of an increased likelihood of default. Combining liquidity requirements with leverage requirements reduces drastically both the likelihood of default and the magnitude of bank losses in default.

Seasoned Equity Offerings: Stock Market Liquidity and the Rights Offer Paradox

AbstractThis paper examines the impact of market liquidity on seasoned equity offerings (SEO) characteristics in France. We find that, besides blockholders’ takeup, liquidity is an important determinant of SEO flotation method choice. We document higher direct equity offering flotation costs, but also improved stock market liquidity after public offerings and standby rights relative to uninsured rights. After controlling for endogeneity in the choice of SEO flotation method, we find that pure public offerings and standby rights are comparable in terms of direct costs and liquidity improvement. Our results provide new insights as to why firms choose public offerings despite apparently higher costs.

Choice of Corporate Debt in China: The Role of State Ownership

We analyze the determinants of debt choices for Chinese firms between bonds and syndicated loans. This issue helps appraise the weak development of bond market in China. We test if flotation costs, asymmetries of information, and renegotiation and liquidation costs influence the choice of debt in line with former studies in the context of regulatory interference in the bond market. We check the role of central state ownership on debt choice in order to assess to what extent corporate debt choices are politically or economically driven. We test these hypotheses on a dataset of 220 listed Chinese firms over the period 2006–2010. We find evidence in favor of the influence of central government ownership on the financing choices of firms it owns, as central state-owned firms are more likely to issue bonds. We also observe limited support for the premise that this influence is stronger for central state-owned firms located closer to the capital. Furthermore, we identify that these companies tend to borrow uniquely on the bond market rather than tapping both debt markets. We provide evidence in favor of the flotation costs hypothesis, but provide mixed evidence for the information asymmetry hypothesis and rather reject the renegotiation and liquidation hypothesis. All in all, our findings show that financial factors play a much more minor role in corporate debt choices compared to other countries, whereas state ownership remain a key determinant of preferring the bond market.

Dressing Up for Premium: A New Perspective on Cross-Listing from China

An interesting phenomenon for Chinese firms that list their stock both in China and abroad is that the overwhelming majority had gone public, and listed, abroad first. We find that when these companies return to China to issue stock and list, they experience poorer post-issuance stock and operating performance in comparison to purely domestic issuers. Also, they raise more funds relative to their sales, leave less money on the table for investors, and incur lower direct flotation costs. Among returning firms, those which raise higher proceeds relative to sales experience poorer long-run stock performance and lower Tobin’s q post issuance. Our results offer a new perspective on cross-listing, which we term “dressing-up-for-premium”. Firms from less-developed markets take advantage of the enhanced visibility and prestige associated with the foreign listing to issue shares domestically at inflated prices and favorable terms, and to raise greater proceeds than they can efficiently use.

The Idiosyncratic Skewness of Seasoned Equity Issuers

We find that the degree of expected idiosyncratic skewness in seasoned equity issuers’ stock returns is an important determinant of flotation costs and post-issue abnormal stock performance. High skewness issuers incur significantly greater offer price discounts, particularly when institutional share allocation is largest, pay higher gross underwriting spreads, and exhibit poorer post-issue stock performance in the three years after issuance, all compared to low skewness issuers. The results suggest that skewness-induced overpricing increases the flotation costs of seasoned equity offers and leads to poor post-issue stock performance.

Choice of Corporate Debt in China: The Role of State Ownership

We analyze the determinants of debt choices for Chinese firms between bonds and syndicated loans. This issue helps appraise the weak development of bond market in China. We test if flotation costs, asymmetries of information, and renegotiation and liquidation costs influence the choice of debt in line with former studies in the context of regulatory interference in the bond market. We check the role of central state ownership on debt choice in order to assess to what extent corporate debt choices are politically or economically driven. We test these hypotheses on a dataset of 220 listed Chinese firms over the period 2006 2010. We find evidence in favour of the influence of central government ownership on the financing choices of firms it owns, as central state-owned firms are more likely to issue bonds. We also observe limited support for the premise that this influence is stronger for central state-owned firms located closer to the capital. Furthermore, we identify that these companies tend to borrow uniquely on the bond market rather than tapping both debt markets. We provide evidence in favour of the flotation costs hypothesis, but provide mixed evidence for the information asymmetry hypothesis and rather reject the renegotiation and liquidation hypothesis. All in all, our findings show that financial factors play a much more minor role in corporate debt choices compared to other countries, whereas state ownership remain a key determinant of preferring the bond market.

Valuing Investment Decisions: Flotation Costs And Capital Budgeting

<p class="MsoNormal" style="text-align: justify; margin: 0in 0.5in 0pt;"><span style="font-size: 10pt;"><span style="font-family: Times New Roman;">We highlight a measurement problem inherent in the prevalent approach to factoring flotation costs in capital budgeting decision-making.<span style="mso-spacerun: yes;">  </span>This arises because the traditional method calculates a higher cost of capital, while keeping the initial cash-flow unchanged.<span style="mso-spacerun: yes;">  </span>We demonstrate an alternate approach that corrects for this problem by assigning a higher initial investment due to flotation costs, while keeping the cost of capital unchanged.</span></span></p>

The role of co-managers in reducing flotation costs: Evidence from seasoned equity offerings

We examine the effect on expected flotation costs of including co-managers in the underwriting syndicate. We consider five components of SEO flotation costs: announcement returns, underpricing, the probability of withdrawals, offering delays, and underwriting spreads. The results show that the characteristics of co-managers participating in syndicates have significant effects on flotation costs, while the effect of the number of co-managers is largely insignificant. Our results are consistent with the notion that highly reputable underwriters and commercial banks serving as co-managers serve a certification role, reducing information asymmetries and, as a result, lowering SEO flotation costs.

Strategic Disclosure, Analyst Behavior and Equity Flotation Costs

We document that the quality of public and private information available to investors improves before seasoned equity offerings (SEO) but deteriorates shortly thereafter. As firms improve their financial communication, analyst earnings forecasts become more accurate and less biased. However, forecast optimism increases after the offering. Firms that enhance the quality of their public information before SEOs increase the likelihood of the offering being a success and reduce the costs of raising finance: underwriters are more likely to exercise their overallotment option, which increases the issue proceeds beyond the prospectus amount, and the underwriting fee decreases. Changes in private information quality induce higher information asymmetry between informed and uninformed investors, increasing flotation costs. The results are robust to controlling for endogeneity in the offering size and underwriter quality. Our findings are consistent with firms strategically improving their information disclosure around seasoned equity issues.

Why Pay Dividends and Issue Equity Simultaneously? The Controlling Corporate Shareholders' View

This paper proposes an explanation, according to a given investment policy and capital structure, for why some firms pay dividends and issue equity simultaneously. For individual investors, this combination invites additional taxes, wasteful flotation costs, and adverse selection. Within the framework presented herein, dividend policy is tailored for the median shareholder's personal consumption-optimum if the shareholder is dividend-seeking. As long as private benefits from saving taxes and transaction costs outweigh pro-rata costs of equity issue, controlling shareholders find it reasonable to receive positive dividends. They compel the firm to issue equity to finance profitable investment projects.

Stock Market Liquidity and the Rights Offer Paradox

This paper contributes to the resolution of the rights offer paradox, using a database of French SEOs. We first document higher direct flotation costs, but also improved stock market liquidity after public offerings and standby rights relative to uninsured rights. We find that blockholder renouncements to subscribe to new shares and stock market liquidity are important determinants of flotation method choice. After controlling for endogeneity in the choice of flotation method, we find that public offerings are cost effective and more liquidity improving than standby rights whereas an uninsured rights offering is the best choice for low liquidity, closely held firms. Our results provide new insights as to why firms choose public offerings despite apparently higher costs.

What Influences Firms to Issue International Bond? An Empirical Study of Relationships between Bond Financing and Firms' Financial Characteristics

In the UK, the share of the international bonds rocketed while the share of government and domestic corporate bonds dropped significantly over the last 10 years. This paper investigates the firm specific factors behind the motivation of issuance of international bonds for the sample of Euro market non-financial bond offerings of UK domiciled firms and uses a sample of domestic corporate bond issuing non-financial UK firms for comparison of these factors. Firm-specific variables are examined based on the determinants of debt choice for both types of firms, namely flotation costs hypothesis, liquidation and renegotiation concerns, asymmetric information, reputation, profitability, growth options and market conditions. To motivate the empirical analysis, a theoretical framework based on the model of financing in international debt markets is employed and used to examine the probability of issuing international bonds by sample firms. The model is further tested using statistical t-tests. Results of this study indicate that international bonds issuing firms are significantly larger in terms of issue size and firm size than firms which issues domestic bonds. This implies that a flotation cost is a concern for an international bond issuing firms. They are high growth firms, and also tend to have higher financial leverage, better liquidation value and stronger reputations than domestic bond issuing firms. The market conditions also seem to provide a favourable opportunity for UK firms to reduce issuing costs by issuing bonds in the international market.

Stock Market Liquidity and the Rights Offer Paradox

This paper contributes to the resolution of the rights offer paradox, using a database of French SEOs. We first document higher direct flotation costs, but also improved stock market liquidity after public offerings and standby rights relative to uninsured rights. We find that blockholder renouncements to subscribe to new shares and stock market liquidity are important determinants of flotation method choice. After controlling for endogeneity in the choice of flotation method, we find that public offerings are cost effective and more liquidity improving than standby rights whereas an uninsured rights offering is the best choice for low liquidity, closely held firms. Our results provide new insights as to why firms choose public offerings despite apparently higher costs.

Seasoned equity offerings: Quality of accounting information and expected flotation costs

Flotation costs represent a significant loss of capital to firms and are positively related to information asymmetry between managers and outside investors. We measure a firm's information asymmetry by its accounting information quality based on two extensions of the Dechow and Dichev [2002. The quality of accruals and earnings: the role of accrual estimation errors. Accounting Review 77, 35–59] earnings accruals model, which is a more direct approach to assessing the information available to outside investors than the more commonly used proxies. Our main hypothesis is that poor accounting information quality raises uncertainty about a firm's financial condition for outside investors, though not necessarily for insiders. This accounting effect lowers demand for a firm's new equity, thereby raising underwriting costs and risk. Using a large sample of seasoned equity offerings (SEOs), we show that poor accounting information quality is associated with higher flotation costs in terms of larger underwriting fees, larger negative SEO announcement effects, and a higher probability of SEO withdrawals. These results are robust to joint determination of offer size and flotation cost components and to adjustments for sample selection bias.

How do Frictions affect Corporate Investment? A Structural Approach

This paper develops and empirically tests a model designed to distinguish the role of real and financing frictions on firms investment, debt financing and equity financing policies. Real frictions include fixed costs of investment and adjustment costs. Financing frictions include taxes, collateral constraints, flotation costs of equity and dividend constraints. Because of financing frictions, all corporate policies are interrelated and depend on average Q. Due to fixed costs of investment and binding financing constraints,the sensitivity of corporate policies to Q is non-linear. The empirical tests demonstrate that both the endogeneity and non-linearities created by real and financing frictions are economically significant. The paper provides a rationale for the documented poor performance of Q-theory in explaining investment, and for the differential performance of the neoclassical investment model in explaining investment and stock returns. The paper extends Q-theory to explain debt and equity issues, and shows that market to book sorts control for non-linearities in investment policies.