Conflict of Interest in Commercial Bank Equity Underwriting

This paper examines the pricing characteristics of initial public offerings underwritten by commercial banks. Assuming IPO underpricing is directly related to ex ante uncertainty, if the market rationally perceives these commercial banks to have a conflict of interest, these securities should have more underpricing than non-commercial bank underwritten initial public offerings (all else being equal). On the other hand, if the market believes that commercial bank involvement signals firm quality, less underpricing should be observed. This topic has recently gained in importance with the passage of the Financial Services Reform Act in November 1999. We find that the underpricing of commercial bank underwritten initial public offerings in which the firm had a previous banking relationship with the underwriter is significantly less than those underwritten by investment banks.     

The choice between rights and underwritten equity offerings: Evidence from Chinese stock markets

We study the choice and valuation effects of alternative flotation methods using a sample of Chinese firms that must meet the return on equity (ROE) thresholds set by the government to raise equity capital. The ROE requirement, although changed over time, seems to play an important role on the valuation and performance of seasoned equity offerings. The analysis of 219 rights and 75 underwritten offerings between 2000 and 2004 shows that Chinese firms that are not qualified for the flotation method with a higher ROE requirement suffer the most at announcement and experience significantly lower buy-and-hold abnormal returns than those that are qualified. Our results suggest that the freedom to choose their preferred flotation method may be valuable to firms that meet the higher ROE requirement. Finally, our probit models identify several determinants of the choice of flotation methods.     

Underwritten Dividend Reinvestment Plans and Conflicts of Interest

We examine conflicts of interests arising from the pricing of seasoned equity offerings (SEOs) in underwritten dividend reinvestment plans (DRIPs). A DRIP is a type of SEO that enables shareholders automatically to reinvest their dividend entitlements in the issuing company's shares. The underwriters have an incentive to sell stock during the DRIP pricing period in order to hedge price risk and/or to reduce the price at which shares are issued. Using individual brokers’ transactions, we show that underwriting brokers engage in an abnormally high level of selling during the issue pricing period. Comparison of pricing period returns between stocks with underwritten DRIPs and a matched sample of non‐underwritten DRIPs shows that significantly more negative returns accrue to firms that have their issues underwritten.     

Why do companies include warrants in seasoned equity offerings?

We analyze the reasons why companies issue units when they raise additional capital. We find that, in contrast to previous evidence, units are not offered to mitigate the agency conflicts or to signal security mispricing as they are predominantly issued during cold periods, in public rather than in rights offerings, and when the issue is underwritten. In addition, the results indicate that companies choose to offer units to increase their offer price flexibility and to underprice their seasoned equity offering so as to minimize the issue cost and the risk of failure of the issue. These results provide support for the net proceeds maximization hypothesis.     

A Comparison of Underwriting Costs of Initial Public Offerings by Investment and Commercial Banks

We examine differences in underwriting costs between commercial‐bank‐Section‐20‐underwritten initial public offerings (IPOs) and investment‐bank‐underwritten IPOs. Our results suggest that total underwriting costs (gross margin plus underpricing) are significantly lower for commercial bank IPOs. The lower cost for commercial bank IPOs is attributable to less severe underpricing for these issues. Gross margin costs generally do not differ between commercial bank and investment bank issues. Furthermore, we find that the long‐run stock price performance for commercial bank issues is superior to that of investment bank issues. That is, lower underpricing for Section 20 issues may not be a short‐run phenomenon. Rather, there appears to be a favorable outcome for investors in the long run for holding IPOs underwritten by Section 20 commercial banks. These results are inconsistent with the conflict of interest hypothesis often associated with merging commercial and investment bank functions in one organization.     

Stock vs. stock-warrant units: evidence from seasoned offerings

Recent theories based on sequential financing and information signaling reveal a special role for warrants. Data from initial public offerings (IPOs) of stock-warrant units have been used to test the theories, and we extend the analysis to seasoned offerings. Consistent with predictions from both families of theories, we find that issues made by smaller and younger firms are more likely to involve stock-warrant units, and firms with greater stock price volatility are more likely to issue units in seasoned offerings. Moreover, firms with relatively high levels of long-term debt, and those whose issues are underwritten by less prestigious underwriters are more likely to employ stock-warrant unit financing. Consistent with information signaling, we find that firms with high managerial ownership are more likely to issue units. Firms that include warrants in their stock offerings are predicted to have experienced higher abnormal stock returns than if they had issued shares alone. Thus, consistent with both theoretical explanations, some firms can reduce capital costs by adding warrants to shares in seasoned offerings.     

MARKET STRUCTURE,CHANGING INCENTIVES,AND UNDERWRITER CERTIFICATION

Early studies find that higher quality underwriters are associated with lower underpricing; however, more recent evidence suggests the opposite relation. By controlling for influences associated with the changing market structure of the underwriter industry, I provide a potential explanation for this conflict, that is, that higher quality underwriters do certify initial public offerings, resulting in lower underpricing. However, effects associated with increasing market shares tend to offset certification benefits, particularly for issues underwritten by the largest investment banks.     

Underpricing of seasoned issues

In this paper we provide a model of the underwritten offerings of new shares of seasoned securities. Our purpose is to explain why the offering price chosen by the underwriter is lower than the market price of the firm's shares. Our model recognizes the interdependence between the markets surrounding the announcement and sale of the new issue and recognizes as well the effect which asymmetric information regarding investor demands has upon the prices in these markets.     

Rights Offerings and Expropriation by Controlling Shareholders

We investigate rights issues and open offers in Hong Kong. We observe that the greater the severity of firms’ management‐agency problems, the more unfavourably shareholders tend to react, leading to more negative cumulative abnormal returns or rights forfeiture. Controlling shareholders do not forfeit rights, and may increase their percentage ownership at deep price discounts by underwriting rights offerings. Our results suggest that, although certain rights offerings can be described as value‐enhancing, many other rights offerings closely resemble the expropriation activities of controlling shareholders.     

Rights Offerings and Corporate Financial Condition

Certain American industrial firms still use equity rights offerings. Most of these offerings are uninsured. I examine firms' financing decisions, and develop the explanation that rights offerings are used by firms in financial distress with difficulty accessing underwriting services. These firms have little to lose from the costs of adverse selection that accompany the lack of underwriter certification of uninsured rights offerings. Probit analysis of 660 seasoned NYSE, Amex, and Nasdaq equity issues between 1983–1999 yields results consistent with my explanation. There is no evidence that variables previously linked to rights usage (e.g., ownership concentration) continue to be relevant to the issue method choice.     

Seasoned Equity Issues in a Closely Held Market: Evidence from France

This paper examines seasoned equity offerings in France.Even though a rights offering is the primary flotation method, French companies are increasingly usingthe relatively expensive public offering method. We show that the market reaction to the announcementof seasoned equity issues is significantly negative for rights issues and insignificantly negative forpublic offerings. Our results suggest that the adverse selection effect is greater for rights issues thanfor public offerings, due to stronger underwriter certification for the public offerings. We find that theshare price effect is positively related to blockholders take-up renouncements for firms with priorconcentrated ownership. For these firms, the favourable ownership dispersion effect offsets the adverse selection effect.     

Determinants of discounts in equity rights issues: An international comparison

Equity rights offerings are the predominant SEO flotation method in many European and Asian countries. Several previous studies focus on rights offerings, but these studies often measure solely the announcement effects of these offerings and pay little attention to the discount. This study seeks to close this gap, explain the discounts on such rights offerings, and determine the drivers of offering discounts with a focus on cultural effects regarding the level of uncertainty avoidance. Based on the existing literature, we develop several hypotheses and find supporting evidence for these hypotheses in our data. Our main finding is that the most important factors for explaining the discount on an equity rights offer are the level of uncertainty avoidance, the quality of a firm, and the level of uncertainty about firm value.     

THE VALUATION OF NEW ZEALAND UNDERWRITING AGREEMENTS

Almost all cash issues by New Zealand listed public companies are by way of a rights issue. This paper examines the terms of 143 issues between 1976 and 1984. Of those issues 86 were underwritten and 57 were not. The paper is concerned with two questions. The first question examines whether there are fundamental differences in the terms of the issues that explain why some issues were underwritten and some were not. The second question examines the extent to which the underwriters' fee corresponds to the value of a put option, where that value is given by an adaptation of the Black Scholes formula. The conclusions are that there are differences in the terms of issues that are underwritten, compared with those that are not, and that the underwriters' fee is substantially in excess of the Black Scholes put value.     

UNDERWRITING SPREADS AND REPUTATIONAL CAPITAL: AN ANALYSIS OF NEW CORPORATE SECURITIES

When entering a new security market, investment banks must establish their reputation. This is done through direct experience in the security market or through reputational capital established in existing security markets. I examine the effects of underwriters' market reputation in publicly underwritten offerings in forty-three financial innovations and find more significant entry barriers for less prestigious underwriters. An analysis of underwriting spreads reveals first-issue pricing advantages due to reputational capital. Unlike the more prestigious underwriters, the less prestigious underwriters reduce spreads upon first entry into each new security market to overcome their lack of market reputation.     

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

This 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.     

Seasoned Equity Issues in a Closely Held Market: Evidence from France

This paper examines seasoned equity offerings in France. Eventhough a rights offering is the primary flotation method, Frenchcompanies are increasingly using the relatively expensive publicoffering method. We show that the market reaction to the announcementof seasoned equity issues is significantly negative for rightsissues and insignificantly negative for public offerings. Ourresults suggest that the adverse selection effect is greaterfor rights issues than for public offerings, due to strongerunderwriter certification for the public offerings. We findthat the share price effect is positively related to blockholderstake-up renouncements for firms with prior concentrated ownership.For these firms, the favourable ownership dispersion effectoffsets the adverse selection effect. JEL Classification: G32,G14 and D80.