Review of Quantitative Finance and Accounting, 17: 63–79, 2001 C 2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
An Empirical Examination of the Pricing of Seasoned Equity Offerings: A Test of the Signaling Hypothesis KHONDKAR E. KARIM∗ Associate Professor, Department of Finance, Accounting, and MIS, College of Business, Rochester Institute of Technology, Rochester, NY 14623-5608, Fax: (716) 475-6920 E-mail:
[email protected] ROBERT W. RUTLEDGE Associate Professor, Department of Accounting, College of Business Administration, Southwest Texas State University, San Marcos, TX 78666-4616 STEPHEN C. GARA Assistant Professor, School of Professional Accountancy, Long Island University - C.W. Post, Brookville, NY 11548 MOJIB U. AHMED Associate Professor, Department of Accounting, University of Dhaka, Dhaka, Bangladesh
Abstract. This paper tests the predictions made by Signaling Theory against the competing Price–Irrelevance Hypothesis (Eckbo and Masulis, 1992). Signaling Theory suggests that the issue price of a security provides a signal of quality of the issuing firm. In contrast, the Price–Irrelevance Hypothesis suggests that equity pricing does not possess information content. This paper investigates the pricing of seasoned equity offerings by examining the role of firm quality and relative firm valuation on issue price discounts. Additionally, this paper investigates the relationship between the issue price discount and the market reaction at the issuance of seasoned equity offerings. The results indicate that firm quality does not have a significant impact on the degree of price discounting by the issuing firm. Relative firm market valuation does appear to be a determinant of the magnitude of discounting in setting the issue price. This paper also provides evidence that seasoned equity offering firms that provide a lower issue-price discount experience a lower stock-price decline following the issuance as compared to firms offering a higher price discount. Key words: seasoned equity offerings, firm valuation and quality, issue–price discount, Tobin’s Q, corporate finance JEL Classification: G12, G14, G32
I. Introduction This paper investigates the pricing of seasoned equity offerings by examining the role of firm quality and relative firm valuation on issue price discounts.1 Additionally, this paper investigates the relationship between the issue price discount and market returns ∗ Address
correspondence to: Khondkar E. Karim.
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surrounding the issue date. Capital markets play a significant role in the theory of corporate finance. Security prices provide a vital signal for corporate investment decisions. Prior literature did not address the process involved in the various methods of raising capital, or of the influence of this process on corporate financial and investment policy. The ultimate goal of any financial policy is to maximize the value of shareholder equity. Empirical evidence suggests that firms do not increase their value by acquiring funds from outside sources (Smith, 1986).2 In order to understand this phenomenon, financial researchers have examined the determinants of the price effects of such issues, and concluded that stock price reaction reflects more than the direct effects of the capital structure change on the firm’s cash flows. An important theory in this aspect is Signaling Theory, which suggests that an issuer, through the action of pricing an issue, signals the quality of the firm (Heinkel and Schwartz, 1986; Cook and Officer, 1996).3 Advocates of this theory argue that the failure of issue offerings is always costly to the issuer. Therefore, issuers set a price that is lower than the actual market price of the firm. If the market price falls at the announcement of the issue, investors will not abstain from participation in the offer. It is likely that the issue price is a valuable source of information to market participants. However, the impact of the issue price on the market price has received little attention in the seasoned equity offerings research (however, see Loderer et al., 1991).4 Using Signaling Theory, Heinkel and Schwart (1986) reported that the subscription discount in uninsured right offerings conveys a signal about the firms’ quality. For example, as issue failure is costly to the issuing firm, and as issuers privately expect the stock price to fall during the equity offer period, they prefer to insure the success of the issue by selecting a lower price in relation to the prevailing market price. As a result, market participants adjust their expected price downward. Proponents of Signaling Theory also argue that security issuers of high quality firms are more likely to set a relatively higher price, while the opposite is expected from low quality firms. Low quality firms run the costly risk of offer failure if they attempt to imitate the high quality firms’ pricing strategy. This study examines 283 seasoned equity issues that occurred between 1991 and 1994. The purpose is to test hypotheses suggesting that high quality or undervalued firms (as compared to low quality or overvalued firms) offer a smaller discount when setting the issue price for seasoned equity.5 Further, firms that offer a smaller discount should experience less negative stock price impact at the issuance of seasoned equity. The remainder of the study is organized as follows. Section II develops the theoretical issues and hypotheses. Section III discusses the data collection and methodology. Section IV describes the results of the empirical analyses. Section V summarizes the conclusions and implications of this research.
II. Theoretical issues and hypotheses A consensus of empirical evidence suggests that seasoned equity offerings have a negative impact on firm value (Myers and Majluf, 1984; Denis, 1994; Loughran and Ritter, 1997;
AN EMPIRICAL EXAMINATION
65
Rangan, 1998; Lee, 1998; Gombola et al., 1999; Shivakumar, 2000). Explanations for this reaction suggest that negative information is conveyed to the market (Nassiripour et al., 1998). Specifically, new offerings may signal overvaluation of the firm’s assets (Myers and Majluf, 1984), the inability of the firm to generate funds internally (Miller and Rock, 1985), the over-investment of free cash flow (Jensen, 1986), or managers’ overstatement of earnings (i.e., earnings management) before announcing seasoned equity offerings (Shivakumar, 2000). Barclay and Litzenberger (1988) concluded that theories of equity offerings, in general, have little or no power to explain the negative stock return following these announcements. The findings of Denis (1994) suggested that investment opportunities play, at best, a minor role in explaining the cross-sectional distribution of equity offering announcement effects.6 The problem with the ex post proxies for measuring growth opportunities, however, is that they measure actual growth rather than the profitability of growth. Contrary to the research cited above, several studies have reported a positive market reaction to the issues of new equity (Nassiripour et al., 1998). Pilotte (1992) reported the effect of growth opportunities to be a possible factor for the positive market reaction. Cooney and Kalay (1993), using a model based on Myers and Majluf’s (1984) pecking order hypothesis, reported a positive market reaction to the announcement of seasoned equity offering by high-growth firms.7 McConnell and Servaes (1990) found a significant positive relation between corporate value and structure of equity ownership where Tobin’s Q was used to measure corporate value. Tobin’s Q plays an important role in many financial interactions (Chung and Pruitt, 1994). Defined as the ratio of market value of a firm to the replacement costs of assets, Q has been employed to explain a number of diverse corporate phenomena. Following the prior literature (McConnell and Servaes, 1990; Denis, 1994; Chung and Pruitt, 1994) this study employed Tobin’s Q as a proxy measure of firm quality. Based on the discussions above, it is suggested that a low price discount (i.e., high issue price relative to market price) will be associated with high quality firms, and high discounts associated with low quality firms, for seasoned equity offerings. Accordingly, the first hypothesis, in alternative form, is: H1: High quality firms offer smaller price discount than low quality firms at the time of setting the price for seasoned equity.8 A seasoned equity issue is a significant avenue for raising capital. Research consistently shows that seasoned equity issues result in decreased firm value. To guard against such value decreases, managers of issuing firms take “self insurance” by making offers at a price discount. The extent of the discount will depend on the manager’s valuation of the firm relative to the market assessment. Managers develop beliefs as to the over- or undervaluation of their firm based on insider information. The price that managers set for seasoned equity offerings reflects such beliefs. If managers believe that the firm is undervalued in the market, then the premium for the insurance will be smaller than for firms that are overvalued in management’s assessment. Thus, the second alternatively formulated hypothesis is: H2: Undervalued firms offer a smaller price discount than overvalued firms in setting the price for seasoned equity.
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Signaling Theory is consistent with the idea that the announcement of seasoned equity offerings by undervalued firms should have a relatively small negative impact on the value of the firm. Consistent with the efficient market phenomenon, inequilibrium in the market should not persist. The market price of undervalued firms should tend to increase, and the market price of overvalued firms should tend to adjust downward. At the time of seasoned equity issuance, managers signal their opinion of the firm’s relative valuation through the extent of price discounting. Undervalued firms are expected to offer a smaller discount than overvalued firms. It is known from the existing empirical research that the announcement of seasoned equity offerings has a negative impact on firm value (e.g., Myers and Majluf, 1984; Loughran and Ritter, 1997; Rangan, 1998; Gombola et al., 1999; Shivakumar, 2000).9 If the above arguments based on Signaling Theory are true, then the market learns which firms are viewed by their managers as overvalued or undervalued through the extent of price discounting that is offered. Thus, the market’s expectations should adjust around the announcement time of seasoned equity offerings. As a result, the third alternatively formulated hypothesis is as follows: H3: Firms issuing seasoned equity with a small price discount experience less negative stock price impact at the equity issuance than firms issuing seasoned equity with a large price discount.
III. Data and methodology Sample of firms The sample used in this study consists of firms with seasoned equity offerings between 1991 and 1994. The sample firms were collected from the August 1995 issue of Disclosure’s Compact Disk on New Issues. The database contains new financing announcement dates from January 1990 through July 1995. The disclosure reports four dates associated with each issue: registration date, effective date, prospectus date, and withdrawn date.10 The registration date was used as the event date for sample selection purposes in this study. In the cases where the registration date was not available, the earlier of the effective date or prospectus date was used. For the purpose of examining the relationship between issue price discount and market returns, the issue date was used as the event date. Samples were matched with other data sources, including Compustat Annual Industrial Tape (1994), and the University of Chicago’s Center for Research on Security Prices (CRSP) (1994) daily stock price records. Consistent with prior literature (Barclay and Litzenberger, 1988; Brous and Kini, 1992) National Association of Securities Dealers Automated Quotations (NASDAQ) listed firms were included in the sample in order to control for sample bias. Thus, the sample includes NASDAQ, New York Stock Exchange (NYSE) and American Exchange (AMEX) listed firms. This resulted in an initial sample size of 1,122 firms. In the first phase of sample refinement, all public utilities and financial companies (including banks, financial services,
AN EMPIRICAL EXAMINATION
67
and insurance companies) were deleted in compliance with previous studies in this area (Cornett and Tehranian, 1994; Eckbo and Masulis, 1995).11 This reduced the sample from 1,122 to 557 issues. The following conditions were set to select the final sample size: (1) If there were more than one issue per issuer within the sample period, then each issue must be at least 730 days apart. This is to insure that the impact of one issue on the market, as well as in the financial statements of the issuers, does not effect the subsequent issue. If two subsequent issues are less than 730 days apart, but more than 365 days apart, then the second issue was dropped from the sample. If both issues are within 365 days of each other, then both issues were dropped from the sample (Thakor, 1993). (2) In order to accommodate a 30-day post-event period in the initial 61-day event window, any issue with an event date after November 30, 1994 was excluded.12 The final sample size consists of 283 issue announcements of which 168 are listed on the NYSE and AMEX, and 115 are listed on the NASDAQ. Of the 283 sample issue announcements, 196 issues were exclusively primary issues and 87 issues were combined primary and secondary issues.13
The quality of firms For the purpose of this study, firm quality is measured using Tobin’s Q. Originally, Tobin’s Q was defined as the ratio of the market value of a firm to the replacement costs of its assets. Tobin (1969) introduced this ratio in order to examine the causal relationship between Q and investment. He argues that if, at the margin, Q exceeds unity, then firms will have incentive to invest since the value of their new capital investment will exceed the cost. If all such investment opportunities were exploited, the marginal value of Q should tend toward unity.14 Tobin suggests that the calculation of Q is practically impossible due to the unavailability of replacement cost data for the sample period. Lindenberg and Ross (1981) developed a procedure to estimate Tobin’s Q, but it is difficult in terms of computational efforts and data availability. Chung and Pruitt (1994) developed a simple formula to approximate Lindenberg and Ross’ estimate of Tobin’s Q.15 The primary advantages of this method include: (1) all data need to calculate Tobin’s Q is readily available in the Compustat annual database; and (2) this approximation is capable of explaining 96.9% of the variability of the Lindenberg and Ross method of approximating Tobin’s Q. Chung and Pruitt’s approximation of Tobin’s Q is used in this study to measure firm quality. In this paper, sample firms’ Q-ratios, as well as industry-median adjusted-Q-ratios, are used to distinguish between high quality firms and low quality firms.16 High quality firms are defined as those that have Tobin’s Q-ratios greater than one (1), and greater than the respective industry median Q-ratio. All other firms are classified as low quality firms. Using this grouping, 94 firms are defined as high quality (high Q) firms, and 189 firms are defined as low quality (low Q) firms.
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Market reaction to seasoned equity issue The stock market reaction to equity offering issuance is measured using daily excess stock returns. These excess returns are estimated from the daily stock return file provided by the Center for Research on Security Prices (CRSP). The daily excess return for any security is estimated as: AR jt = R jt − (α j − β j Rmt )17,18
(1)
where AR jt = excess return on security j for day t, R jt = return on security j for day t, Rmt = daily equally-weighted index for all common stocks on NYSE, AMEX, and NASDAQ firms on the CRSP tape on event day t, α j = estimation period intercept of security j, β j = OLS estimates of security j’s market model slope parameter. A 120-day estimation period is used for the estimation of the market model parameters, and a 61-day event period is used for capturing the issue effect of seasoned equity offerings on the daily return of the issuers’ stock. Five cumulative abnormal returns (CAR’s): CAR0 (0), CAR0,1 , CAR−1,0 , CAR−1,1 and CAR−5,5 were calculated in order to perform the regression analysis. The sample firms were divided between undervalued and overvalued firms based on the median ratio of issue price to the 22-day pre-event average market price. Undervalued firms were defined as those having a “higher than median” ratio (of issue price to 22-day pre-event average market price), and overvalued firms were defined as those with a “lower than median” ratio.19 This resulted in 141 undervalued firms and 142 overvalued firms. The discount was calculated by taking difference between the issue price and the 5-day pre-event average market price. The sample firms were further divided into two subgroups based on the amount of price discount offered. Firms offering a discount higher than the sample median 5-day pre-event discount are termed high discount firms (n = 141), and the remaining firms are termed low discount firms (n = 142), where the discount for each firm is calculated as follows: Issue price discount = 1 − (Issue price/Market price)
(2)
Abnormal returns were calculated using the methods described above in equation (1) for the various sample partitions. Subsequently, t-tests were performed to look at the significance of the difference between groups. Table 1 contains a descriptive summary of the sample. Table 1 is divided into six panels. Panel A describes the full sample. The remaining panels provide descriptive statistics for the sample when considering the type of issue (Panel B), exchange listing (Panel C), firm quality (Panel D), relative firm valuation (Panel E), and the amount of discount (Panel F).
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AN EMPIRICAL EXAMINATION Table 1. Descriptive statistics of full sample of 283 seasoned equity offerings 1991–1994 Mean
Median
Std. Dev.
Max
Min
Obs
0.9950
0.9899
0.2862
4.6667
0.3628
283
0.0181 0.2460
0.0246 0.1584
0.2929 0.3833
3.8555 4.9138
−0.6069 0.0000
283 280
0.7288
0.4124
1.0648
8.0535
0.0000
265
4.0120
0.4573
17.5421
213.7010
0.0101
266
91.6422
53.0000
158.9315
1782.5000
2.6813
283
0.9919
0.9934
0.2991
4.6667
0.3965
196
0.0158 0.2371
0.0134 0.1424
0.3109 0.4398
3.8555 4.9138
−0.6059 0.0137
196 193
0.8634
0.5381
1.1864
8.0535
0.0000
182
4.4077
1.0342
13.9730
135.4470
10.0750
183
101.4840
58.7438
174.1676
1782.5000
2.6813
196
1.0018
0.9828
0.2563
2.5263
0.3628
87
0.0232 0.2658
0.0502 0.2169
0.2494 0.2107
1.4742 1.0071
−0.6069 0.0000
87 87
0.4338
0.2423
0.6441
3.6607
0.0000
83
3.1394
0.1508
23.4484
213.7010
10.5210
83
68.6599
46.2500
115.2125
1053.0000
11.6000
87
1.0037 0.0057
0.9950 0.0133
0.1515 0.1451
2.3030 1.2029
0.3965 −0.6059
168 168
0.1694
0.1146
0.1591
1.0101
0.0000
168
Panel A: Full sample Offer price/event day market price 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Panel B: Type of issue Only primary issues Offer price/event day market price 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Primary and secondary issues combined Offer price/market price on the event day 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Panel C: Exchange listing NYSE & AMEX firms Offer price/event day market 5-day pre-event ave. discount price Issue proceeds/total capital outstanding
(continued)
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Table 1. (continued) Mean Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $)
Median
Std. Dev.
Max
0.9883
0.5476
1.2303
8.0535
6.0184
1.1040
21.6328
129.5654
70.5000
0.9823
Min
Obs
0.0000
169
213.7010
0.03340
169
195.7589
1782.5000
3.3750
168
0.9669
0.4108
4.6667
0.3628
155
0.0362
0.0618
0.4253
3.8555
−0.6069
115
0.3608
0.2314
0.5560
4.9138
0.0137
115
0.4119
0.2149
0.5609
3.2080
0.0000
96
0.5162
0.1313
1.5336
14.4218
0.0101
97
36.2413
21.0490
33.6163
208.5000
2.6813
115
1.0135
0.9934
0.4039
4.6667
0.3965
94
−0.0015
0.0245
0.4220
3.8555
−0.6059
94
0.1681
0.1292
0.1543
1.0071
0.0000
94
0.306359
0.1765
0.4498
3.4045
0.0000
94
0.8741
0.2199
0.0019
13.4980
0.0101
94
89.0368
54.2313
124.2548
1053.0000
3.3000
94
0.9857
0.9880
0.2047
2.5263
0.3628
189
0.0278
0.0248
0.2009
1.4742
−0.6069
189
0.2854
0.1847
0.4528
4.9138
0.0137
186
0.9610
0.6216
1.2235
8.0535
0.0000
171
5.7269
0.8396
0.0245
213.7010
16.4600
172
92.9380
51.4250
173.9150
1782.5000
2.6813
189
NASDAQ firms Offer price/event day market price on the event day 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Panel D: Firm quality High Q (quality) firms Offer price/event day market price 5-day pre-event ave. discount Issue proceeds /total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Low Q (quality) firms Offer price/event day market price 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $)
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AN EMPIRICAL EXAMINATION Table 1. (continued) Mean
Median
Std. Dev.
Max
Min
Obs
0.9000
0.9338
0.1369
1.2319
0.3628
142
0.1205 0.2932
0.0848 0.1719
0.1279 0.0513
0.1229 4.9138
−0.6069 0.0065
142 141
0.7359
0.4332
1.0749
8.0535
0.0000
133
5.0238
0.3429
0.0237
213.7010
0.00101
134
76.0200
38.7063
108.0306
649.0000
2.7600
142
1.0906 −0.0851 0.1981
1.0165 −0.0144 0.1495
0.3574 0.3675 0.1607
4.6667 3.8555 0.8630
0.8857 −0.1236 0.0000
141 141 139
0.7216
0.4123
1.0585
7.0262
0.0000
132
2.9849
0.6117
0.0065
406.5300
0.0022
132
107.3753
64.1250
196.5413
1782.5000
2.6813
141
0.8909 0.1312 0.2974
0.9286 0.0882 0.1744
0.1289 0.1196 0.5080
1.0784 3.8555 4.9138
0.3628 0.0246 0.0137
141 141 140
0.7387
0.3176
1.2292
8.0535
0.0000
130
2.6164
0.0310
0.0102
95.8620
0.0010
131
74.5147
37.6000
100.7544
649.0000
2.7600
141
1.0983 −0.0943 0.1946
1.0207 −0.0208 0.1416
0.3546 0.3632 0.1776
4.6667 0.0248 1.0101
0.9211 −0.6069 0.0000
142 142 140
0.7193
0.5009
0.8826
7.0262
0.0000
135
5.3662
0.6843
0.0223
213.7010
0.0022
135
108.6491
63.0250
199.6356
1782.5000
2.6813
142
Panel E: Firm valuation Overvalued firms Offer price/market price on the event day 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Undervalued firms Offer price/event day market price 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Panel F: Amount of discount High discount firms Offer price/event day market price 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $) Low discount firms Offer price/event day market price 5-day pre-event ave. discount Issue proceeds/total capital outstanding Capital structure of firms in the year before the issue Total assets in the preceding year (in bill. $) Total issue size (in mill. $)
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IV. Results The first hypothesis (H1) predicts that high quality firms offer a smaller discount than low quality firms at the time of setting the issue price for newly issued seasoned equity. In order to test this hypothesis, the sample was partitioned into high and low quality firms. A t-test was performed to determine if there was a significant difference in the issue-price discount from the 5-day pre-event average market price between the two groups. Although high quality firms offered a lower relative price discount than low quality firms (−0.0015 vs. 0.0278), this difference was not statistically significant. The sample firms were further subdivided both by the nature of issue (primary vs. combined primary and secondary) and by the exchange on which the issue took place (NYSE/AMEX vs. NASDAQ). These results are reported in Table 2. The only reported significant difference is between low quality NYSE/AMEX firms and low quality NASDAQ firms (−0.0042 vs. 0.0787, respectively), where low quality NYSE/AMEX firms are found to have significantly less discounts ( p < 0.05). No significant differences were observed between any other groupings. Hypothesis two (H2) states that undervalued firms offer smaller discounts than over– valued firms at the time of setting the price for newly issued seasoned equity. This is Table 2. Mean price discounts for seasoned equity offerings partitioned by firm quality
Overall sample
High Quality Firms (n = 94)
Low Quality Firms (n = 189)
Significance Level of Differences
−0.0015
0.0278
Not significant
−0.0428 (n = 56) 0.0593 (n = 38) Not significant
0.0393 (n = 140) −0.0048 (n = 49) Not significant
Not significant
0.0276 (n = 52) −0.0375 (n = 42) Not significant
−0.0042 (n = 116) 0.0787 (n = 73) Less than 0.05 level
Not significant
Type of issue Primary only Combined primary and secondary significance level of differences
Not significant
Exchange listing NYSE & AMEX NASDAQ Significance level of differences
Not significant
Notes: (1) Mean price discount on the issue is computed from 5-day pre-event average market price. (2) The level of significance of mean differences was calculated by a using t-test. (3) High quality firms are those that possess a Tobin’s Q greater than one in the event year as well as greater than their respective industry median Tobin’s Q. All other firms are classified as low quality. (4) Primary offers include only primary seasoned equity offerings and combined offers include both primary and secondary offerings on the same date.
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AN EMPIRICAL EXAMINATION Table 3. Mean discounts for seasoned equity offerings partitioned by firms relative valuation
Overall sample
Undervalued Firms (n = 141)
Overvalued Firms (n = 142)
Significance Level of Differences
−0.0851
0.1205
Less than 0.01 level
−0.0801 (n = 102) −0.0980 (n = 39) Not significant
0.1199 (n = 94) 0.1216 (n = 48) Not significant
Less than 0.01 level
−0.0492 (n = 94) −0.1569 (n = 47) Not significant
0.0753 (n = 74) 0.1697 (n = 68) Less than 0.01 level
Less than 0.01 level
Type of issue Primary only Combined primary and secondary Significance level of differences
Less than 0.01 level
Exchange listing NYSE & AMEX NASDAQ Significance level of differences
Less than 0.01 level
Notes: (1) Mean price discount on the issue is computed from 5-day pre-event average market price. (2) The level of significance of mean differences was calculated by a using t-test. (3) Undervalued firms are those, in the opinion of their respective managers, possessing a relatively lower market value at the time of issuance of the seasoned equity. (4) Primary offers include only primary seasoned equity offerings and combined offers include both primary and secondary offerings on the same date.
due to an attempt by firm managers to capitalize the benefits of underpricing in the market. To test this hypothesis, the sample was partitioned on the firm’s relative valuation (i.e., undervalued or overvalued). Table 3 indicates that undervalued firms were observed to offer a significantly lower discount than overvalued firms at the time they issued seasoned equity (−0.0851 vs. 0.1205, p < 0.01). This result persists even when the sample is subdivided based on the type of issue (primary: −0.0801 vs. 0.1199, or combined primary and secondary: −0.0980 vs. 0.1216) ( p < 0.01), as well as by the exchange on which the issue took place (i.e., NYSE and AMEX: −0.0492 vs. 0.0753, or NASDAQ: −0.1569 vs. 0.1697) ( p < 0.01). Thus, the results strongly support hypothesis two. The third hypothesis (H3) predicts firms issuing seasoned equity at a lower discount experience less negative stock price impact at the issuance of seasoned equity. Results supporting this hypothesis are found in Tables 4 and 5. Table 4 contains the percentage abnormal returns and cumulative percentage abnormal returns for the overall sample and the high- and low-discount subgroups for the eleven days surrounding the event date. Table 5 contains cumulative percentage abnormal return data for different event windows around the event date, and the level of significance for differences between the groups. Firms offering smaller discounts at the issuance of seasoned equity are observed to experience significantly lower value
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Table 4. Eleven-day percentage abnormal returns (AR%) and cumulative percentage abnormal returns (CAR%) surrounding event date for full sample and discount subgroups
Day Relative
AR%
t-value of AR
p-value of AR
CAR%
%CAR > 0
Sign Z
Obs
0.4281 0.4211 0.3930 0.3860 0.4737 0.2737 0.3860 0.4632 0.4983 0.4702 0.4491
−2.4879 −2.7248 −3.6726 −3.9095 −0.9478 −7.7005 −3.9095 −1.3032 −0.1185 −1.0662 −1.7771
283 283 283 283 283 283 283 283 283 283 283
Full sample −5 −4 −3 −2 −1 0 1 2 3 4 5
0.16 −0.24 −0.33 −0.39 0.08 −1.65 −0.78 0.02 0.16 −0.10 0.02
0.1242 −1.2352 −2.8642 −2.6499 1.0861 −10.6168 −5.0039 0.4440 0.2948 −0.9330 0.7883
0.4507 0.1096 0.0025 0.0046 0.1398 0.0000 0.0000 0.3289 0.3843 0.1764 0.2160
0.16 −0.08 −0.41 −0.79 −0.71 −2.36 −3.14 −3.12 −2.96 −3.06 −3.04
Partitioned by discount level High discount firms −5 −4 −3 −2 −1 0 1 2 3 4 5
0.31 −0.29 −0.61 −0.52 −0.08 −2.23 −1.02 −0.26 0.42 −0.22 −0.25
0.4946 −2.1390 −3.4189 −1.8738 −0.9343 −10.4259 −4.5188 −1.0562 0.8155 −1.1465 −0.7165
0.3109 0.0172 0.0004 0.0317 0.1760 0.0000 0.0000 0.1465 0.2082 0.1269 0.2375
0.31 0.02 −0.60 −1.12 −1.19 −3.43 −4.45 −4.71 −4.28 −4.51 −4.76
0.3901 0.3972 0.3262 0.4184 0.4114 0.1986 0.3546 0.4114 0.5036 0.4114 0.4326
−2.6949 −2.5265 −4.2108 −2.0212 −2.1896 −7.2425 −3.5370 −2.1896 0.0000 −2.1896 −1.6843
141 141 141 141 141 141 141 141 141 141 141
0.01 −0.18 −0.05 −0.26 0.24 −1.08 −0.55 0.31 −0.10 0.01 0.29
−0.3148 0.3788 −0.6464 −1.8737 2.4524 −4.6193 −2.5681 1.6698 −0.3922 −0.1780 1.8181
0.3768 0.3528 0.2596 0.0317 0.0078 0.0000 0.0057 0.0488 0.3478 0.4295 0.0358
0.01 −0.17 −0.22 −0.48 −0.24 −1.32 −1.87 −1.56 −1.66 −1.65 −1.36
0.4653 0.4444 0.4583 0.3542 0.5347 0.3472 0.4167 0.5139 0.4931 0.5278 0.4653
−0.9167 −1.4167 −1.0833 −3.5833 0.7500 −3.7500 −2.0833 0.2500 −0.2500 0.5833 −0.9167
142 142 142 142 142 142 142 142 142 142 142
Low discount firms −5 −4 −3 −2 −1 0 1 2 3 4 5
75
AN EMPIRICAL EXAMINATION Table 5. Cumulative percentage abnormal returns surrounding event date
Total sample (n = 283)
CAR%0 (t0 )
CAR%0,1 (t0,1 )
CAR%−1,0 (t−1,0 )
CAR%−1,1 (t−1,1 )
CAR%−5,5 (t−5,5 )
−1.65 (−10.6168)
−2.43 (−3.6615)
−1.57 (−2.2268)
−2.35 (−2.7862)
−3.04 (−2.0217)
−2.23 (−10.4259) −1.08 (−4.6193)
