Liquidity Changes around Seasoned Equity Issuance: Public Offerings versus Private Placements

I investigate whether firms that issue equity, in public offerings or private placements, have improved on liquidity in the secondary market. Transaction costs, price impacts, and trading activity are examined. Results show that public offering stocks become considerably more liquid in all three dimensions. For private placement stocks, there is some evidence that trading volume increases, but effective spread and temporary price impact decline less than market‐wide changes. Furthermore, I study the behaviors of participants in the newly issued equity market. Analyses indicate that underwriters, analysts, and market makers all contribute to liquidity changes, but in different aspects.     

Why do firms issue private equity repeatedly? On the motives and information content of multiple PIPE offerings

This study examines why private equity issues tend to be a repeated source of financing for public firms. We test the recent operational needs theory of public equity issuance within the context of repeated private equity issues. We find that repeated PIPE issuers burn through cash quickly and do not reach the standards of information transparency or profitability needed for a successful public equity offering. This has implications for investor composition and the market response to a PIPE. Initial PIPE offerings are characterized by substantial diversity in investor type. In successive transactions firms increasingly rely upon hedge funds, who extract greater price discounts and more often require cash flow rights as opposed to control rights. As firms select a path of repeated PIPEs to raise funds, successive issues become uninformative to the market. We conclude that, for small public firms, the same motive underlies public equity offerings and repeated private equity offerings—an acute need for cash.     

Motivations for public equity offers: An international perspective

This paper examines the motivations for public equity offers, using a sample of 17,226 initial public offerings and 13,142 seasoned equity offerings from 38 countries between 1990 and 2003. We estimate the uses of funds raised in both initial and seasoned offerings. Firms appear to spend incremental dollars on both R&D and capital expenditures, consistent with the investment financing explanation of equity issues. However, consistent with the mispricing explanation, high market to book firms tend to save more cash and offer a higher fraction of secondary shares in SEOs than low market to book firms.     

Product market effects of IFRS adoption

Prior literature finds that International Financial Reporting Standards (IFRS) adopters enjoy lower financing costs subsequent to IFRS adoption. We predict and find that mandatory IFRS adopters exploit lower financing costs to increase market share vis-à-vis non-adopters. This effect is robust across several different model specifications in a sample capturing the universe of public and private firms in the EU, in a matched sample of public and private firms, and in a public firm sample comparing mandatory and voluntary IFRS adopters. We further find that IFRS is associated with an increase (decrease) in industry sales concentration (competition), consistent with large public firms increasing market share. In supplemental analyses, we find that mandatory adopters issue more equity and debt after IFRS adoption and that larger market share gains accrue to those mandatory IFRS adopters that issue more equity and debt after IFRS adoption. Overall, we provide evidence of unintended product market consequences of IFRS adoption.     

The mystery of zero-leverage firms

We present the puzzling evidence that, from 1962 to 2009, an average 10.2% of large public nonfinancial US firms have zero debt and almost 22% have less than 5% book leverage ratio. Zero-leverage behavior is a persistent phenomenon. Dividend-paying zero-leverage firms pay substantially higher dividends, are more profitable, pay higher taxes, issue less equity, and have higher cash balances than control firms chosen by industry and size. Firms with higher Chief Executive Officer (CEO) ownership and longer CEO tenure are more likely to have zero debt, especially if boards are smaller and less independent. Family firms are also more likely to be zero-levered.     

Equity cross-listings in the U.S. and the price of debt

Using a large panel from 46 countries over 20 years, we find that non-U.S. firms issue corporate bonds more frequently and at lower offering yields following an equity cross-listing on a U.S. exchange. Firms issue more bonds through public offerings instead of private placements and in foreign markets rather than at home, in both cases at significantly lower yields. Moreover, the debt-related benefits are concentrated among firms domiciled in countries with less private benefits of control, efficient debt enforcement, and developed bond markets, suggesting that equity cross-listings cannot completely offset the impact of weak home country institutions. The results support the notion that the monitoring, transparency, and visibility benefits brought about by equity cross-listings on U.S. exchanges are valuable to bond investors.     

Financial integration and emerging markets capital structure

This paper investigates the impact of country-level financial integration on corporate financing choices in emerging economies. Examining 4477 public firms from 24 countries, we find that corporate leverage is positively related to credit market integration and negatively related to equity market integration. As integration proceeds to higher levels, high-growth firms seem to obtain more debt than low-growth firms; large firms seem to obtain more debt - especially long-term debt - and issue more equity than small firms. Also, there is evidence that firms are able to borrow more funds in countries with more efficient legal systems during integration process.     

The decision to first enter the public bond market: The role of firm reputation,funding choices,and bank relationships

This paper uses survival analysis to investigate the timing of a firm’s decision to issue for the first time in the public bond market. We find that firms that are more creditworthy and have higher demand for external funds issue their first public bond earlier. We also find that issuing private bonds or taking out syndicated loans is associated with a faster entry to the public bond market. According to our results, the relationships that firms develop with investment banks in connection with their private bond issues and syndicated loans further speed up their entry to the public bond market. Finally, we find that a firm’s reputation has a “U-shaped” effect on the timing of a firm’s bond IPO. Consistent with Diamond’s reputational theory, firms that establish a track record of high creditworthiness as well as those that establish a track record of low creditworthiness enter the public bond market earlier than firms with intermediate reputation.     

International Cross‐Listings and Subsequent Security‐Market Choices: Evidence from ADRs

We study the link between the attributes of American depositary receipt (ADR)‐listed firms and their post‐listing security‐market choices. We find that developed market firms are more likely to issue equity and debt than their emerging market counterparts. Furthermore, we find that large firms are more likely to issue debt and less likely to issue equity. When we examine locations where ADR firms raise their capital, we find that firms originating from countries where the protection of minority shareholders is weak are more likely to issue debt on their home markets and less likely to issue debt on international markets (excluding U.S. markets). Furthermore, ADR firms originating from developed (emerging market) countries are more (less) likely to issue their equity on their domestic markets and less (more) likely to issue equity on international markets (excluding U.S. markets).     

Market power and reputational concerns in the ratings industry

This paper studies the incentives of rating agencies to reveal the information that they obtain about their client firms. In the model, rating agencies seek to maximize their reputation and protect their market power. They observe public information and obtain either precise or noisy private information about a firm. Reputational concerns dictate that a rating reflects private information when it is precise. However, when private information is noisy, two situations arise. In a monopoly, the rating agency may ignore private information and issue a rating that conforms to public information. Under some conditions, it may even become cautious and issue bad ratings ignoring both types of information. With competition, however, it has incentives to contradict public information as a way to pretend that it holds precise private information. Moreover, it may become more likely to issue good ratings in an attempt to protect market power.     

Earnings management,market discounts and the performance of private equity placements

Private equity placement data allow us to determine whether sophisticated investors can uncover the true value of firms. This can be done by defining sophisticated investors as those who meet the stringent participation requirements of the private equity market. Our results show private equity issuing firms overstate their earnings in the quarter preceding private equity placement announcements and that sophisticated investors do not ask for a fair discount when purchasing the shares of the private issuing firms. We also find evidence showing that the reversal of the effects of pre-issue earnings management is a significant determinant of the long-term performance of private issues. Results further show that post-issue stock performance and operating performance of firms using “aggressive” earnings management significantly underperform those using more “conservative” earnings management.     

UNDERPRICING OF IPOS THAT FOLLOW PRIVATE PLACEMENT

In this study we examine the underpricing of initial public offerings (IPOs) by firms that have private placements of equity before their IPOs (PP IPO firms). We find that PP IPOs are associated with significantly less underpricing than their peers. Furthermore, PP IPOs are associated with lower underwriting spreads, more reputable underwriting syndicates, and greater postissue analyst coverage as compared to IPOs that are issued by their industry peers under similar market conditions. Consistent with the implications of the information asymmetry explanation for IPO underpricing, our findings suggest that companies could benefit by conveying their quality via successful pre‐IPO private placements that help reduce the cost of going public.     

Equity market timing and capital structure: International evidence

We investigate the equity market timing hypothesis of capital structure in major industrialized (G-7) countries. As claimed by its proponents, we find that leverage of firms is negatively related to the historical market-to-book ratio in all G-7 countries. However, this negative relationship cannot be attributed to equity market timing. We find no association between equity issues and market-to-book ratios at the time of equity financing decisions by Japanese firms. Firms in all G-7 countries, except Japan, undo the effect of equity issuance and the impact of equity market timing attempts on leverage is short lived. This is inconsistent with the prediction of the equity market timing hypothesis and more in line with dynamic trade-off model.     

Equity and debt issuance by firms violating GAAP

We examine security issuance in restated periods by firms that misreport financial statements and find that only a small per cent of such firms issues securities in the restated period. Investors are misled by mistakes made by firms issuing equity more so than other restating firms at the initial announcement of misreported earnings, but are not misled by mistakes made by debt‐issuing firms. Equity‐issuing firms that manage earnings to beat analyst expectations experience abnormally high returns in the restated period prior to security issuance. Firms that restated more reports and have higher pre‐mistake returns are more likely to issue equity. High leverage, firm size and number of restated periods are positively associated with the likelihood of debt issuance by restating firms.     

Public Equity and Audit Pricing in the United States

To what degree are audit fees for U.S. firms with publicly traded equity higher than fees for otherwise similar firms with private equity? The answer is potentially important for evaluating regulatory regime design efficiency and for understanding audit demand and production economics. For U.S. firms with publicly traded debt, we hold constant the regulatory regime, including mandated issuer reporting and auditor responsibilities. We vary equity ownership and thus public securities market contextual factors, including any related public firm audit fees from increased audit effort to reduce audit litigation risk and/or pure litigation risk premium (litigation channel effects). In cross‐section, we find that audit fees for public equity firms are 20–22% higher than fees for otherwise similar private equity firms. Time‐series comparisons for firms that change ownership status yield larger percentage fee increases (decreases) for those going public (private). Results are consistent with litigation channel effects giving rise to substantial incremental audit fees for U.S. firms with public equity ownership.     

Employee sentiment and stock option compensation

The use of equity-based compensation for rank-and-file employees is a puzzle. We analyze whether the popularity of option compensation may be driven by employee optimism, and show that optimism by itself is insufficient to make option compensation optimal. The crucial insight is that firms compete with financial markets as suppliers of equity to employees and that employees’ access to the equity market restricts firms’ ability to profit from employee optimism. Firms must be able to extract some of the implied rents even though employees can purchase company equity in the financial markets. Such rent extraction becomes feasible if employees prefer the stock options offered by firms to the equity offered by the market, or if the traded equity is overvalued. We provide empirical evidence that firms use broad-based option compensation when boundedly rational employees are likely to be excessively optimistic about company stock, and when employees are likely to strictly prefer options over stock.     

Equity with Warrants in Private Placements

We examine private equity with warrant (unit) placements and compare them with private equity placements. Firms making unit placements are smaller, younger, riskier, and characterized by higher information asymmetry than equity‐placing firms. Furthermore, unit‐placing firms experience good pre‐placement stock performance; however, their post‐placement performance is poor and worse than that of equity‐placing firms. We also find that very few of the placed warrants are in the money at expiration. Our results are consistent with the window of opportunity hypothesis and the theory that warrants are especially desirable to a clientele of overoptimistic investors.     

The Wealth Effects of Reducing Private Placement Resale Restrictions

Recently, the US Securities and Exchange Commission reduced resale restrictions on Rule 144 private placements from 12 months to 6 months with the intention of lowering the cost of equity capital for issuing firms. In Canada, similar regulatory changes were adopted several years ago, providing a unique opportunity to test the wealth effects of reducing private placement resale restrictions. We find that shortening resale restrictions reduces the liquidity portion of offer price discounts, and thus lowers the cost of equity capital for issuing firms, but has no significant effect on announcement‐period abnormal returns after controlling for issuer type. However, there is a fundamental shift in the types of firms making private placements of common stock after the legislation‐induced easing of resale restrictions. Specifically, we find that smaller firms and firms with greater information asymmetry are less likely to issue privately placed common stock after the legislative change, suggesting that the easing of resale restrictions reduces the costly signal that helps to overcome the Myers and Majluf (1984) underinvestment problem.     

Corporate equity ownership, investment, and product market relationships

This paper examines the effect of corporate equity ownership on investment when firms have product market relationships. Firms have incentives to hold long equity positions when their products are complements. These equity positions induce the firms to increase their real investment expenditures. In contrast, firms have incentives to hold short equity positions when their products are substitutes. These short positions commit the firms to a more aggressive product market stance, and also result in increased real investment expenditures. Our model offers an explanation for the empirical relationship between the establishment of corporate equity stakes and increased investment spending documented by Allen and Phillips (2000).     

THE ENDOGENEITY OF INFORMATION ASYMMETRY AND CORPORATE FINANCING DECISIONS

Firms endogenize the extent of information asymmetry by choosing the optimal level and channels of direct communication with the capital markets. Firms choose more communication when they have a greater potential demand for external financing (characterized by higher growth, less cash, and higher leverage). We demonstrate that a higher level of communication is associated with a higher probability of equity issuance. We further document that the previously observed negative market reaction to seasoned equity offering (SEO) announcements is attributed only to low‐communication firms; high‐communication SEO firms experience no significant adverse market reaction.