Seasoned Equity Issues Research Articles

Corporate governance and long run performance of seasoned equity issuers

This paper examines the effect of corporate governance on the likelihood of issuing Seasoned Equity Offerings (SEO) between 1990 and 2005. It also examines the long-run post-issue performance using operating and stock return measures. Our results suggest that well-governed firms are less likely to issue equity. Nevertheless, when they do so, they outperform both matching non-issuers and issuers with minimal shareholders’ rights from pre- to post-issue—with the highest operating out-performance occurring in the two post-issue years. A negative correlation exists between the post-issue performance and the anti-takeover measures, primarily, the protection associated with management entrenchment. Nonetheless, measures of board structure do not appear to affect the post-issue operating performance. Overall, corporate governance appears to be an effective internal control mechanism that restrains managers’ incentives to either take an SEO issuance decision that does not serve the interests of shareholders or invest the capital raised in value-destroying projects.

Price Support by Bank-Affiliated Mutual Funds

Fund managers are double agents; they serve both fund investors and owners of management firms. This conflict of interest may result in trading to support securities prices. Tests of this hypothesis in the Spanish mutual fund industry indicate that bank-affiliated mutual funds systematically increase their holdings in the controlling bank stock around seasoned equity issues, at the time of bad news about the controlling bank, before anticipated price drops, and after non-anticipated price drops. The results seem mainly driven by bank managers’ incentives. Ownership of asset management companies thus matters and can distort capital allocation and asset prices.

The market and operating performance of Chinese seasoned equity offerings

This article examines the short-term market and the long-term operating performance of Chinese seasoned equity issues (Seasoned Equity Offerings (SEOs)). Employing data for 596 rights offerings and 181 private placements for the period 1998 to 2004, we find significant positive short-term market reaction for both rights offerings and private placements; however, the long-term operating performance of the firms offering private placements is significantly better than the rights offering firms. In China, firms issuing rights offerings are required to adhere to strict rules set by the Chinese Securities Regulatory Commission (CSRC). These firms must meet minimum standards with respect to earnings and profitability before being permitted to issue rights offerings. Firms issuing private placements are not required to meet the same strict earnings/profitability requirements. Our results suggest that the regulatory oversight is important for the short-term market reaction of the equity issuing firms. However, it...

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.

Patterns in the Timing of Corporate Event Waves

Corporate events happen in waves. In this paper, we examine the timing patterns of five different types of corporate event waves (new stock and seasoned equity issues, stock and cash-financed acquisitions, and stock repurchases) using a comprehensive dataset of more than 151,000 corporate transactions over the 25-year period 1980-2004. We document a distinctive pattern, previously undocumented in the literature, in the way stock-related waves form. Corporate waves seem to start with new issue waves (SEO preceding IPO waves), followed by stock-financed merger waves, followed in turn by repurchase waves. Our results hold over separate decades and across industries. Our results seem consistent with both the neoclassical efficiency hypothesis and the misvaluation hypothesis, and there are distinct periods when one or the other appears dominant.

Illiquidity Risk and the Long-Run Underperformance of Seasoned Equity Issues in the Spanish Market

This paper presents new evidence on potential risk-based explanations for the low SEO returns in the year after the issue. Specifically, we analyse whether the issue leads to a long-term higher stock liquidity that implies that SEO stocks have lower expected return due to lower exposure to liquidity risk factor. Therefore, we investigate if Spanish SEO firms experience significant changes in long-term liquidity after the issue. Results suggest that SEO-firm liquidity increases significantly in the year after the issue. Finally, we explore the post-performance of SEO firms explicitly accounting for liquidity risk. In particular, we employ the three factor model by Fama and French (1993) extended in one additional liquidity factor based on the illiquidity measure proposed by Amihud (2002). Our results show that underperformance disappears when accounting for liquidity risk.

Intended use of proceeds and the long-run performance of seasoned equity issuers

We investigate the relation between seasoned equity issuers' stated intended use of proceeds and their subsequent long-run stock and operating performance. Stated intended uses of proceeds are: investment, recapitalization, and general corporate purposes. We find that issuers stating recapitalization or general corporate purposes experience abnormally poor performance in the subsequent three years, but issuers stating investment display little or no subsequent underperformance. These results suggest that issuers with specific plans to use the proceeds for investment purposes are credibly signaling profitable investment opportunities, whereas issuers without specific investment plans are more likely to be opportunistic market timers. Consistent with a timing motive, the secondary component of the offering is significantly larger when the issuer is not specific about investment plans.

Seasoned Equity Offerings, Investment Risk and Financial Constraints

We evidence that Canadian seasoned equity issuers post a significant pre-issue stock price run-up and a significant post-issue underperformance, even when controlling for an investment risk factor, as in Lyandres, Sun and Zhang (2008). Our results do not corroborate the investment/risk hypothesis; neither are our results in line with the timing hypothesis: Canadian issuers exhibit poor operating performance, are generally financially constrained or distressed, and not able to time the market. We propose that the observed pattern can be attributed to a conjunction of the positive effect of the slack in the financial constraint and irrational pricing. Our results confirm this proposition.

Preferred Stock: Some Insights into Capital Structure

Capital structure theory and empirical analysis has focused almost exclusively on the choice between debt and equity. Preferred stock has received relatively little attention, in contrast, even though this market, in the U.S., represented $868 billion in new capital during the period 1999 to 2005. This empirical study focuses on the reactions of equity holders through an event study analysis and of debt holders through a default spread analysis to the announcement of 427 preferred issues. We find that the equity abnormal announcement returns are positive for straight preferred stock announcements, when they are combined with convertible preferred announcements, the equity abnormal returns are -0.65%, which is much closer to zero than to the magnitude of SEO announcements; furthermore, these returns are higher for firms with greater earnings potential and lower financial distress risk. We also find that credit default swap spreads decrease upon announcement of a preferred issue. These results are consistent with the hypothesis that equity holders interpret the preferred issue, on average, as debt, since the magnitude of the usual negative reaction to seasoned equity issuance is not found and bondholders interpret the preferred issue as equity, since the issuance does not increase the firm's default risk.

Capital Structure and Security Issuance Under Heterogeneous Beliefs

Using a sample of debt and seasoned equity issues from 1980-2004 and different proxies of investor optimism and the dispersion in investor beliefs, we empirically analyze, for the first time in the literature, the effect of heterogeneous beliefs among outside investors on the capital structure and security issuance choices made by a firm. The paper consists of three parts: In the first part of the paper, we study how heterogeneous beliefs affect a firm's choice between equity and debt for raising external financing; in the second part of the paper, we study the effect of heterogeneous beliefs on the price impact of a security issue on the firm's equity; and in the third part of the paper, we study the effect of heterogeneous beliefs on the long-term stock performance of equity and debt issuers. Our empirical results can be summarized as follows. First, the probability of a firm issuing equity rather than debt is increasing in both the average level of optimism of outside investors and the dispersion in outsider beliefs. Second, the price impact on the firm's equity is negative for an equity issue and zero for a debt issue; further, the price impact of an equity issue is decreasing (more negative) as the dispersion in outsider beliefs is greater. Finally, while the long-term stock returns to both equity and debt issuers is negative, the stock returns to equity issuers is significantly more negative than that of debt issuers. Further, the more optimistic outsiders are on average about a firm's prospects at the time of an equity issue and the more dispersed their beliefs, the more negative the long-term stock returns to the firm. Overall, our results indicate the importance of heterogeneity in investor beliefs as a determinant of the financing decision of a firm.

Long-run underperformance of seasoned equity offerings: Fact or an illusion?

This paper uses Australian data from 1984 to 1993 to show that the long-run underperformance of seasoned equity offerings is related to the definition of ‘long-run’. We demonstrate that following the period delimited by other writers as the long-run, issuing firms turn around in their performance and in fact outperform their corresponding benchmarks, sometimes more than making up for the initial losses. We show that the initial underperformance affects the issues of companies performing more than one seasoned equity offering (SEO) in a similar fashion. Our results, the first to examine Australian long-run SEO performance, show that underperformance of Australian seasoned equity issues is dependent on the definition of the ‘long-run’. (Allen and Patrick [D.E. Allen, M. Patrick, Some further Australian evidence on the long-run performance of initial public offerings: 1974–1984, Pac. Basin Financ. Markets 2A (1996) 133–155. [1]] examined long-run IPO performance.) When long-run is defined as 12 years instead of the usual 5 years, SEOs can be clearly seen to turn around their performance particularly during years six and seven. A series of regression results point to a number of factors that bear influence on the extent of the initial underperformance. Decreased ex-ante uncertainty associated with older firms causes a negative relationship between the age and the extent of underpricing. Moreover, the greater is the SEO cost specifically associated with underpricing of the new equity, the greater is the underperformance that follows the issue.

Rights issues, private benefits and negative-NPV investments

This paper discusses the use of rights issues when interest conflicts between controlling shareholders and minorities exist, due to the existence of private benefits that the former can extract from the value of listed company. While the literature considers the issue of pre-emptive rights as an essential tool to protect minorities from expropriation, we propose that pre-emptive rights are used to enforce the subscription of seasoned equity issues. We define an abuse condition as the case when a controlling shareholder choose discretionally an issuing price, granting a discount with respect to the market price, and "enforce" minorities to undertake a negative-NPV investment. Minorities do so because they are minimizing an exit cost that is greater than zero. As the rights issue never fails under these conditions, we define this phenomenon as "enforced subscription". This model fits the Italian legal framework and many other international contexts where rights issues are dominant. We report the case of Alitalia’s rights issue in 2005 as a typical example of "enforcement at work". As rights issues at a high discount often involve an abuse of power by the controlling shareholders, we argue that their use should be carefully regulated.

International Evidence on the Determinants of the Decision to List

This paper offers empirical insights into the determinants of listing activity using, annual data sampled across 38 exchanges. Listing activity in developed countries stock markets is influenced by a range of variables which capture stock market and business conditions. The single most important factor in explaining the current level of listing activity, however, is the past level of listing activity. For emerging stock markets, none of the variables tested possessed any real explanatory power. Evidence is also found to suggest that high listing activity is accompanied by an increase in seasoned equity issues.

Do Rights Issues Really Protect Minorities? Empirical Evidence on the Italian Case

This paper discusses the use of rights issues in a context where interest conflicts between controlling shareholders and minorities are due to the existence of private benefits that the former can extract from the value of a traded company. While the literature considers the issue of preemptive rights as an essential tool to protect minorities from expropriation, we propose a model where rights are used to enforce the subscription of seasoned equity issues, even at negative conditions for the market. We define an abuse condition, that allows a controlling shareholder to choose discretionally an issuing price, granting a discount with respect to the market price, so that minorities either undertake the issue or place the rights, minimizing an exit cost that is, in this case, greater than zero. As the rights issue never fails under these condition, we define this phenomenon as enforced subscription. An analysis of rights issues in Italy over the decade 1996-2005 follows, providing evidence of an abuse of rights issues carried out by companies in financial distress. As rights issues at a high discount often involve an abuse of power by the controlling shareholder, we argue that their use should be carefully regulated.

Underwriter Certification: Evidence from Seasoned Equity Issues

This proposal examines the relationship between certification and the reputation of underwriters. Based on seasoned equity offers between 1976 and 2005, in the first part of this proposal I document a positive abnormal announcement return associated with the selection of an underwriter that is more reputable than expected given publicly available firm and issue characteristics. Having an issue underwritten by a surprisingly more reputable underwriter is associated with a durable decrease in bid-ask spreads lasting about three quarters. This effect and the aforementioned one on announcement returns are both stronger with firms that have higher levels of asymmetric information ahead of the offering. These results are consistent with the quality of the underwriter being directly related to the often mentioned certification effect, consisting of a reduction in information asymmetry. In the second part of this proposal, I analyze the firm's use of a commercial vs. an investment bank in equity underwriting, while considering the underwriter's reputation and the endogeneity of the fees. Firms with higher levels of asymmetric information are more prone to have their equity issues underwritten by a commercial bank. The firms react to the fees that would be charged by the different bank types and reputations. After controlling for the underwriter's reputation, the effect on announcement returns of a surprise announcement of being underwritten by a commercial bank is directly related to the firm's level of information asymmetry. This is consistent with the commercial banks' competitive advantage in certification residing in economies of scope/ information transfers, and the investment banks' relative strength consisting of an outsider certification capability that is less variable across the spectrum of firms transparency.

Does market misvaluation help explain share market long‐run underperformance following a seasoned equity issue?

AbstractWe examine the relation between pre‐seasoned equity offering (SEO) announcement date misvaluation and long‐run post‐SEO performance for a large sample of Australian SEOs made between 1993 and 2001. Our study is motivated by inconsistent findings across countries with respect to the SEO long‐run underperformance anomaly first documented in the USA, inconclusive findings with respect to the hypothesis that managers exploit market misvaluation when timing equity issues, and a recent Australian Stock Exchange proposal to loosen SEO regulation. We find SEO firms underperform common share market benchmarks for up to 5 years after the announcement. Using a residual income valuation method, we show that this underperformance is related to pre‐announcement date misvaluation. An unexpected result is that underperformance and misvaluation are more severe for private placements than rights issues. Institutional factors unique to the Australian setting, particularly the large number of smaller loss‐making firms among private placement issuers, appear to explain the poorer performance of placement firms. Our results are robust to various measurement methods and assumptions, and demonstrate the importance of researching SEO performance in alternative institutional settings.

Is the long-run underperformance of seasoned equity issues irrational? Evidence from Spain

We investigate if the long-run underperformance in the year after the issue of a sample of Spanish SEO firms is related to behavioural biases that lead investors to slowly adjust their pre-issue overoptimism. We also examine the existence of arbitrage costs that preclude mispricing from being corrected rapidly by sophisticated investors who act as arbitrageurs. Our findings support the contention that small SEO firms are overpriced at the time of the issue and suggest that their post-underperformance is related to arbitrage costs, where transaction costs play an important role although holding costs do not.

The Multijurisdictional Disclosure System and Value of Equity Offerings

AbstractThe Canada and US multijurisdictional disclosure system (MJDS) implemented in 1991 lowered the indirect barriers for investors and issuers by easing reporting and disclosure requirements for cross‐border issues. This paper examines the impact of the MJDS and related regulatory changes on Canada–US equity market segmentation using a sample of Canadian seasoned equity offerings in the 1991–1998 period. We find that the number of cross‐border issues by Canadian firms increased, and the typical negative stock price reaction that accompanies seasoned equity issues declined over time, supporting increased integration between the two markets after the MJDS. We also document that cross‐border issues experience about 1.4 per cent lower negative stock price reaction compared with domestic issues, consistent with Canada–US market segmentation. We find mixed support for Merton's (1987) investor recognition hypothesis. While Canadian firms cross‐listed in the US experience a less adverse price reaction to their cross‐border offerings compared with their non‐US‐listed peers, there is no significant difference between the two groups in the case of purely domestic issues.

The Seasoned‐Equity Issues of UK Firms: Market Reaction and Issuance Method Choice

Abstract: This study examines the seasoned equity issues of companies traded on the London Stock Exchange. Recent regulatory changes have allowed UK firms more discretion in choice of issue approach, and this has led many firms to issue through placing in preference to a rights issue. Having first documented the trend towards increasing use of placings, we go on to identify an interesting subset of placings that are less likely to be anticipated by the market, and find a significant positive market reaction to such placings, which contrasts with the significant negative reaction we find for issues by rights. We also examine the choice of seasoned equity issuance method, focusing on the choice between placings versus rights issues. We develop a model to explain the choice of equity issue method that achieves a high level of predictive accuracy.

Pricing of Seasoned Equity Offers and Earnings Management

AbstractThis study examines the relations between earnings management by firms offering seasoned equity issues and the pricing of their offers. We hypothesize that seasoned equity offering (SEO) firms that employ aggressive accounting decisions also more aggressively push up their offer prices, thereby leading to a decrease in the degree of underpricing. Consistent with our prediction (the issuer's greed hypothesis), evidence indicates that SEO firms that make opportunistic accounting decisions issue new shares at inflated prices. Our findings remain robust after controlling for other determinants of SEO underpricing and the possible endogeneity of pricing and earnings management.