Shelf Registrations and Shareholder Wealth: A Comparison of Shelf and Traditional Equity Offerings

This study examines the effect of issuing common stock on shareholder wealth under two alternative methods of registration, shelf registration under the Securities and Exchange Commission's Rule 415 and the traditional method of registering shares for immediate sale. The stock price reactions accompanying security registrations and offerings over the period from March 1982 through November 1983 are examined for over two hundred issues. A negative price reaction is observed for traditional and shelf registrations for both utility and non-utility issuers. No statistically significant difference is observed between shelf and traditional registrations. Further negative price reactions precede the offerings of these securities.     

Deregulation in investment banking: Industry concentration following Rule 415

This paper examines activity in the investment banking industry around the passage of Rule 415 (the ‘shelf registration regulation’). Our empirical results document that corporations that issued securities via shelf registrations chose to do so using significantly fewer and more prestigious underwriters per issue than corporations that issued securities prior to Rule 415. Although the trend toward fewer underwriters occurred for both shelf and non-shelf registrations, it is more pronounced for the shelf registered issues. Further, we show that stockholders of small, less prestigious underwriters experienced significantly larger stock price decreases than stockholders of larger, more prestigious underwriters during the period in which Rule 415 was passed.     

The revival of shelf-registered corporate equity offerings

We report that traditional seasoned equity offerings (SEOs) are no longer firms' preferred choice for raising seasoned public equity. Traditional offerings have recently been surpassed by shelf-registered offerings in terms of both annual frequency and total capital raised. This represents a dramatic shift from the 1980s, during which the overwhelming majority of firms favored traditional over shelf-registered offerings. We find that the growth in shelf use is related to firms increasingly valuing and using the option feature of shelf registration to defer offerings. Moreover, the evidence indicates that the way firms now use shelf offerings resolves the shelf under-certification problem and results in no larger market penalties and significantly lower underwriter fees relative to non-shelf offerings. Finally, firms often use universal shelf filings and choose between debt and equity offerings based on the prevailing relative market conditions.     

A SURVEY OF U.S. CORPORATE FINANCING INNOVATIONS: 1970–1997

In the past 30 years, major changes have occurred not only in the kinds of securities issued, but also in the way securities are issued and in the national markets where they are issued. Traditional registered offerings have been partly displaced by shelf registered offerings and Rule 144A private offerings. And once exclusively domestic U.S offerings are increasingly being supplemented by foreign market offerings by U.S. companies, and by simultaneously domestic and foreign offerings. In 1997, for example, 11% of all proceeds raised by U.S. corporations were issued in one or more foreign markets. Of the $105 billion raised in these offerings, $31 billion was denominated in currencies other than the U.S. dollar.
While traditional securities still dominate the market, the authors' research indicates that the pace of innovation in the design of securities also increased markedly during the 1980s and has continued strong throughout the 1990s. In 1997, for example, innovative securities accounted for almost 30% of total domestic offerings. Three of the most common objectives of such securities have been (1) to manage the interest rate (and other financial price) risk faced by investors and issuers; (2) to reduce information costs faced by investors when buying securities from issuers with better information about their own prospects (a condition known as "information asymmetry"); and (3) to increase the tradability of financial assets.     

Information spillovers around seasoned equity offerings

We examine information spillovers in the context of seasoned equity offerings (SEOs). Rival firms react significantly positively (0.26%) to primary SEO announcements, indicative of a competitive effect, but negatively (− 0.35%) to secondary share announcements, which is evidence of a contagion effect. Consistent with the view that primary equity offerings signal favorable industry prospects because firms presumably issue new shares to invest in profitable projects, we find that the rival response is positively related to analysts' EPS growth forecasts. However, when insiders are selling their shares through a secondary offer, this may suggest overvaluation and thus negatively impacts rival firms. Consistent with this view, we find when VCs sell through a secondary offerings, rivals experience a more significant negative reaction. We find rival firms are more likely to follow their peers and conduct a primary SEO if the market reacts favorably to their peer's SEO announcement. Finally, rival firms outperform secondary share issuers of equity, but not primary share issuers. Collectively, the findings support the view that insiders take advantage of windows of opportunity when they sell their own shares, but not when they raise capital for investing purposes.     

THE COSTS OF EQUITY ISSUES SINCE RULE 415: A CLOSER LOOK

In this paper I re-examine the effect of shelf registration (SEC Rule 415) on the underwriter fees of firms issuing equity. The data indicate that lower fees cannot be obtained by typical firms using the shelf procedure. Rather, previously documented evidence of lower underwriter spreads for shelf issues appears to be due to a selection bias in the firms choosing shelf registration. These firms enjoy a comparative cost advantage over other firms regardless of the registration procedure used.     

Business Groups and Tunneling: Evidence from Private Securities Offerings by Korean Chaebols

We examine whether equity‐linked private securities offerings are used as a mechanism for tunneling among firms that belong to a Korean chaebol. We find that chaebol issuers involved in intragroup deals set the offering prices to benefit their controlling shareholders. We also find that chaebol issuers (member acquirers) realize an 8.8% (5.8%) higher (lower) announcement return than do other types of issuers (acquirers) if they sell private securities at a premium to other member firms, and if the controlling shareholders receive positive net gains from equity ownership in issuers and acquirers. These results are consistent with tunneling within business groups.     

An Empirical Investigation of Short-Selling Activity Prior to Seasoned Equity Offerings

We investigate the nature and magnitude of short-selling activity around seasoned equity offerings, the relation between short-selling activity and issue discounts, and the consequences of the Securities and Exchange Commission (SEC's) adoption of Rule 10b-21 in response to concerns about manipulative short-selling practices. Seasoned offerings are characterized by abnormally high levels of short selling and option open interest. Higher levels of such activity are related to lower expected proceeds from the issuance of new shares. Where it could not be circumvented, Rule 10b-21 appears to have curbed short-selling activity and reduced issue discounts.     

THE COSTS OF RAISING CAPITAL

We report the average costs of raising external debt and equity capital for U.S. corporations from 1990 to 1994. For initial public offerings (IPOs) of equity, the direct costs average 11.0 percent of the proceeds. For seasoned equity offerings (SEOs), the direct costs average 7.1 percent. For convertible bonds, the direct costs average 3.8 percent. For straight debt issues, the direct costs average 2.2 percent, although they are strongly related to the credit rating of the issue. All classes of securities exhibit economies of scale, although they are less pronounced for straight debt issues. IPOs also incur a substantial indirect cost due to short-run underpricing. Most large equity offers include an international tranche, although debt issues do not.     

The Effect of Shareholder Approval of Equity Issuances Around the World

Mandatory shareholder approval of equity issuances varies considerably across and within countries. In the United States and a few other countries, management typically needs the approval of only its board of directors to issue common stock. In most countries, however, by law or stock exchange rule, shareholders must vote to approve equity issuances when using certain methods or contemplating offers that exceed a specified fraction of outstanding shares. In some countries, shareholders must approve all equity issuances. Even in the United States, shareholder approval is mandatory under certain circumstances. The differences in the stock market reaction to shareholder‐approved equity issuances and to issues undertaken unilaterally by management are strikingly and consistently large. When shareholders approve stock issuances, whether public or rights offerings, or private placements, the average announcement returns are significantly positive, on the order of 2%. But when managers issue stock without shareholder approval, as in the case of U.S. public offerings, returns are significantly negative and 4% lower, on average, than for shareholder‐approved issues. What's more, the closer in time the shareholder vote is to the issue date, and the greater the required plurality (say, two‐thirds instead of half the vote required for approval), the more positive is the market reaction to the issue—and these findings hold for each of the three main kinds of offerings that take place in all 23 countries in the author's sample. Also telling, in countries where shareholder approval is required, such as Sweden and Malaysia, rights offers predominate over public issues. But in countries like the U.S. and Japan, where managers may generally issue stock without shareholder approval, public offers predominate over rights issues. These findings suggest that agency problems—the tendency of corporate managements to put their own interests before their shareholders'—play a major role in equity issuances. Such findings are also largely inconsistent with the adverse selection, market timing, and signaling explanations that currently dominate academic thinking about equity issuances by public corporations.     

Insider trading and the long-run performance of new security issues

This paper uses insider trading around new security issues to provide evidence of managerial timing ability. I show that insider sales increase and purchases decrease prior to issues of information-sensitive securities (convertible debt and equity) by industrial firms. I then examine the relation between insider trading and subsequent stock returns. Although not all equity issues are motivated by overvaluation, those where managers sell prior to the issue are more likely to be. I find that industrial firms with abnormal insider selling underperform in the long run, whereas those with abnormal buying do not. There is no evidence of a relation between abnormal selling and future performance for utility offerings, however. Overall, the evidence is consistent with poor long-term performance being due to overvaluation.     

Product market advertising and new equity issues

We analyze the interaction between a firm's product market advertising and its corporate financing decisions. We consider a firm that faces asymmetric information in both the product and financial markets and that needs to raise external financing to fund its growth opportunity (new project). Any product market advertising undertaken by the firm is visible to the financial market as well. In equilibrium, the firm uses a combination of product market advertising, equity underpricing, and underfinancing (raising a smaller amount of external capital than the full information optimum) to convey its true product quality and the intrinsic value of its projects to consumers and investors. The following two predictions arise from our theoretical analysis for the relation between product market advertising and equity underpricing around new equity issues. First, firms choose a higher level of product market advertising when they are planning to issue new equity, compared with situations in which they have no immediate plans to do so. Second, product market advertising and equity underpricing are substitutes for a firm issuing new equity. We empirically test the above two predictions and find supporting evidence in the context of firms making initial public offerings and seasoned equity offerings.     

THE VALUATION EFFECTS OF FREQUENT COMMON STOCK ISSUANCES

Previous empirical studies show that announcements of seasoned common stock registrations and issuances lead to significant reductions in common stock prices and shareholder wealth. Nevertheless, some firms issue common stock frequently. Our empirical study of nonutility firms that issued common stock four or more times within ten years shows that market reactions to announcements of offerings and to registrations are less unfavorable than typical reactions for infrequent issuers. A cross-sectional analysis reveals no unique characteristics that distinguish frequent issuers from one-time common equity issuers. In fact, the only detectable characteristic unique to the firms is that they issue common stock frequently.     

Does equity market timing have a persistent impact on capital structure? Evidence from China

This paper uses the change in individual securities accounts as a measure of equity funding supply to examine whether the persistent timing effect on capital structure exists for the Chinese equity market. This new equity timing measure avoids previous criticisms over a timing measure not being independent of a firm's characteristics of capital structure. Our empirical results show that this new measure is an effective market timing variable for issuing equity in the Chinese equity market, and that a persistent effect of equity market timing on firm capital structure exists for more than 7 years. This paper offers evidence that the market conditions of equity funding supply play an important role in corporate financing decisions in China.     

SEASONED EQUITY OFFERINGS FOR NEW INVESTMENT AND THE INFORMATION CONTENT OF INSIDER TRADES

Significant negative valuation effects are widely acknowledged for firms announcing seasoned equity offerings. This result is consistent with theoretical models linking new equity issues to increased adverse-selection costs, lower management ownership in the firm, misuse of free cash flow, or expectations for earnings declines. Also increasingly evident, insiders trade around corporate announcements. We test the hypothesis that insider trading and announcements of new equity issues serve as joint signals in the market's evaluation of prospective capital investment projects. Our findings are consistent with the hypothesis that insider trading is related to market reaction to announcements of new equity issues.     

The Puzzling Increase in the Underpricing of Seasoned Equity Offerings

Using a sample of over 3,000 seasoned equity offerings (SEOs) from 1983 to 1998, we test the hypothesis that the U.S. Securities and Exchange Commission's Rule 10b‐21, which disallows the covering of short positions with newly issued SEOs, makes pre‐offer stock prices less informative, which, in turn, causes the new seasoned equity to be priced at a discount. Consistent with the hypothesis, we find that the year the rule went into effect coincides with the year from which we begin observing significant SEO discounts. Further, we find that ex ante uncertainty and SEO discounts are positively related. We also conduct tests specifically related to short selling, and we also consider an exhaustive set of alternative explanations for the discounts. Based on all of the evidence, we conclude that it is the rule that makes issue discounts larger in the 1990s.     

EXPRESS LANE OR TOLLBOOTH IN THE DESERT? THE SEC'S FRAMEWORK FOR SECURITY ISSUANCE

U.S. companies that need capital may choose between selling securities in the private and public markets. These venues differ in terms of direct issuance costs, the required information disclosed, the liability incurred, and the mechanics of the capital-raising process itself. During the last two decades, the Securities and Exchange Commission (SEC) has deregulated private offerings by broadening their investor base and increasing secondary market liquidity. At the same time, SEC policy has bifurcated the offering process in the public market into two distinct segments based largely on company size and seasoning. Large public issuers have seen a gradual deregulation and acceleration of their capitalraising processes. Important changes for issuers include allowing them to incorporate information into registration statements by reference to Exchange Act reports, to use shelf registration to speed up offers, and to place securities offshore with less regulatory uncertainty. Though small issuers enjoy some of the benefits of these changes, deregulation of their offerings has been somewhat less pronounced. In a Commission report and a subsequent concept release, the SEC indicates it may restructure and unify these three disparate strands of capital raising through an innovative schema of registering companies rather than securities.     

Liquidity,the Value of the Firm,and Corporate Finance*

The theory of corporate finance has been based on the idea that a company's market value is determined mainly by just two variables: the company's expected aftertax operating cash flows or earnings, and the risk associated with producing them. The authors argue that there is another important factor affecting a company's value: the liquidity of its own securities, debt as well as equity. The paper supports this argument by reviewing the large and growing body of evidence showing that differences—and, perhaps even more important, sudden changes—in liquidity can have major effects on the pricing of corporate stocks and bonds or, equivalently, on investors' required returns for holding them. The authors also suggest that the liquidity of a company's securities can be managed by corporate policies and actions. For those companies whose value is likely to be increased by having more liquid securities—which is by no means true of all companies (for example, mature firms with little need for outside equity are likely to benefit from having more concentrated ownership and hence less liquidity)—management should consider actions such as reducing leverage and substituting dividends for stock repurchases as well as measures designed to increase the effectiveness of their disclosure and investor relations program and the size of their retail investor base.     

Investment Bank Reputation,Information Production,and Financial Intermediation

We model reputation acquisition by investment banks in the equity market. Entrepreneurs sell shares in an asymmetrically informed equity market, either directly, or using an investment bank. Investment banks, who interact repeatedly with the equity market, evaluate entrepreneurs' projects and report to investors, in return for a fee. Setting strict evaluation standards (unobservable to investors) is costly for investment banks, inducing moral hazard. Investment banks' credibility therefore depends on their equity-marketing history. Investment banks' evaluation standards, their reputations, underwriter compensation, the market value of equity sold, and entrepreneurs' choice between underwritten and nonunderwritten equity issues emerge endogenously.     

DO BANK RELATIONSHIPS MATTER IN PUBLIC DEBT OFFERINGS?

Finance theorists have argued that banks have a comparative advantage over public debtholders and other suppliers of debt both in gathering information about and in monitoring corporate borrowers. Although underwriters of public debt issues and private placements have access to inside information when executing specific transactions, commercial bankers have ongoing relationships with their corporate borrowers that have often been built up over years. Perhaps more important, banks are also often in a better position and have stronger incentives than a dispersed collection of bondholders to keep tabs on what the borrowers do after receiving the capital.
This theoretical argument received striking empirical support from a study by Chris James published in 1987 in the Journal of Financial Economics. Entitled "Some Evidence on the Uniqueness of Bank Loans," the study documented that announcements of new bank lending aggreements by public firms are received positively, on average (and in a large majority of cases) by the stock market. This finding offered a pointed contrast to the neutral to sharply negative stock-price responses that accompany announcements of almost all other kinds of securities offerings, including private placements of debt and public offerings of straight debt.
In this article, the authors discuss their own recently published study that provides another piece of evidence of the value added by banking relationships. Specifically, the authors report that the first public debt offerings of companies with bank relationships carry spreads that are 85 basis points less than the spreads of initial debt issues by comparable firms without bank relationships. As the authors interpret their findings, a banking relationship not only helps to "certify" the value of corporate borrowers to their stockholders, but also provides other lenders with valuable "cross-monitoring" benefits that are reflected in lower borrowing costs.