Seasoned equity offerings,market timing,and the corporate lifecycle

Both a firm's market-timing opportunities and its corporate lifecycle stage exert statistically and economically significant influences on the probability that it conducts a seasoned equity offering (SEO), with the lifecycle effect empirically stronger. Neither effect adequately explains SEO decisions because a near-majority of issuers are not growth firms and the vast majority of firms with high M/B ratios and high recent and poor future stock returns fail to issue stock. Since without the offer proceeds 62.6% of issuers would run out of cash (81.1% would have subnormal cash balances) the year after the SEO, a near-term cash need is the primary SEO motive, with market-timing opportunities and lifecycle stage exerting only ancillary influences.     

Product market competition and credit risk

This study theoretically and empirically investigates effects of product market competition on credit risk. We first develop a real-options-based structural model in a homogeneous oligopoly and show that credit spreads are positively related to the number of firms in an industry. The disparity of firm size in an industry is relevant to both product market competition and credit risk, and we therefore extend the model to an asymmetric duopoly case. In particular, we demonstrate that credit spreads of relatively small (large) firms within an industry are positively (negatively) related to Herfindahl-Hirschman index, and the relative firm size in an industry is an important determinant of credit risk. The models’ implications are empirically scrutinized by a reduced-form hazard model and generally supported. By performing out-of-sample analyses, the results demonstrate that firm size together with the interaction terms between intra-industry firm size dummies and competition intensity can effectively predict default.     

Long-run performance of Spanish seasoned equity issues with rights

This paper analyzes the long-run effect on shareholders' wealth and firms' operating performance of the right offering decision in Spain. The evidence shows that the stock price of firms' issuing rights substantially underperform the different benchmarks employed. It has also been observed that these companies experience a decrease in accounting profitability for some pre- to postissue periods. An excessive optimism about the long-term prospects of equity issuers could explain these results.     

Private equity and regulatory capital

Regulatory capital requirements for European banks have been put forward in the Basel II Capital Framework and subsequently in the capital requirements directive (CRD) of the EU. We provide a detailed discussion of the capital requirements for private equity investments under different approaches. For the internal model approach we present a structural model that we calibrate to a proprietary dataset. We modify the standard Merton structural model to make it applicable in practice and to capture stylized facts of private equity investments. We also implement the early default feature with a fast simulation algorithm. Our results support capital requirements lower than in Basel II, but not as low as in CRD, thereby giving adverse incentives to banks for using advanced risk models. A sensitivity analysis shows that this finding is robust to parameter uncertainty and stress scenarios.     

Country-specific equity market characteristics and foreign equity portfolio allocation

Do country-specific equity market characteristics explain variations in foreign equity portfolio allocation? We study this question using comprehensive foreign equity portfolio holdings data and different measures of country-specific equity market factors for 36 host countries. Employing panel data econometric estimations, our investigation shows that foreign investors prefer to invest more in larger and highly visible developed markets which are more liquid, exhibit a higher degree of market efficiency and have lower trading costs. The findings imply that by improving the preconditions necessary for well-functioning capital markets, policymakers should be able to attract higher levels of foreign equity portfolio investments.     

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.     

Corporate derivatives use and the cost of equity

We investigate the relation between derivatives use and corporations’ cost of equity capital. Using a large sample of non-financial firms, we compute and analyze (i) the relative cost of equity of firms that use derivatives and those that do not; and (ii) the change in cost of equity experienced by firms initiating derivatives programs. We find that the cost of equity of derivatives users is lower than non-users by 24-78 basis points. Our results are robust to specifications that account for potential endogeneity related to a firm’s derivatives use and capital structure decisions. We further find that the reduction in the cost of equity is attributable to both lower market beta and SMB beta, suggesting that firms use derivatives to reduce their financial distress risk and that this distress risk has a systematic component that is priced in the market. Finally, the observed reductions in the cost of equity tend to be largest for smaller firms and for firms utilizing currency and interest rate derivatives.     

Firm-specific risk and equity market development

We show that the increase in firm-specific risk in the US stock market is the result of new listings by riskier companies. In addition, our results explain why prior researchers have found that growth opportunities, profit margin, firm size, and industry composition (among other factors) are related to increases in firm-specific risk. The new listing effect is not driven by small companies becoming riskier but instead by a riskier sub-sample of the economy becoming publicly traded. These results are consistent with prior research that documents time trends in financial market development.     

Understanding seasoned equity offerings of Chinese firms

We examine the empirical relevance of standard theories explaining the motivation of Seasoned Equity Offerings (SEOs) in the Chinese context. Analyzing Chinese SEOs during 1994-2008 and controlling for other factors reflecting features of Chinese corporate finance, we find that Chinese SEOs are mostly motivated by timing the market. Financing for investment and growth receives weak empirical support. We do not obtain any consistent evidence supporting both the tradeoff and the agency theories. In addition, we find that the firm’s SEOs behavior varies between rights issues and public offerings and across different periods along with the progress of China’s market transition. Our results show that Chinese listed firms in general behave similarly as their counterparts in other countries concerning SEOs decisions in that they issue SEOs when there are opportunities to take advantage of market overvaluation. These results are consistent with the well-documented convergence trend of corporate SEOs behavior of firms around the world. In addition, our findings challenge the conventional perception on Chinese SEOs that controlling shareholders use SEOs as a means to expropriate minority shareholders.     

Managerial entrenchment, equity payout and capital structure

I develop a contingent claims model to examine the impacts of managerial entrenchment on capital structure and security valuation. The analysis shows that managers’ self-interested leverage choices deviate significantly from the optimal leverages that maximize firm values, partially explaining the suboptimal leverage ratios observed empirically (Graham, 2000). Both the extent and sensitivity of the deviations are affected by firm characteristics, debt features and default solutions. The shareholder-manager conflicts over risk level and cash payout vary dynamically with a firm’s financial health. Managerial entrenchment does not mitigate the agency problems of debt since managers’ discretionary decisions on milking properties or asset substitution could be driven by incentives to increase their own utility.     

Bond market access and investment

Prior research has shown that differential access to debt markets significantly affects capital structure. In this paper, we examine the effect of access to debt markets on investment decisions by using debt ratings to indicate bond market access. We find that rated firms are more likely to undertake acquisitions than nonrated firms. This finding remains even after accounting for firm characteristics, for the probability of being rated, and in matched sample analysis as well as in subsamples based on leverage, firm size, age and information opacity. Rated firms also pay higher premiums for their targets and receive less favorable market reaction to their acquisition announcements relative to non-rated firms. However, the average announcement returns to rated acquirers are non-negative. Collectively, these findings suggest that the lack of debt market access has a real effect on the ability to make investments as well as on the quality of these investments by creating underinvestment, instead of simply constraining overinvestment.     

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.     

Capital structure,equity ownership and firm performance

This paper investigates the relationship between capital structure, ownership structure and firm performance using a sample of French manufacturing firms. We employ non-parametric data envelopment analysis (DEA) methods to empirically construct the industry’s ‘best practice’ frontier and measure firm efficiency as the distance from that frontier. Using these performance measures we examine if more efficient firms choose more or less debt in their capital structure. We summarize the contrasting effects of efficiency on capital structure in terms of two competing hypotheses: the efficiency-risk and franchise-value hypotheses. Using quantile regressions we test the effect of efficiency on leverage and thus the empirical validity of the two competing hypotheses across different capital structure choices. We also test the direct relationship from leverage to efficiency stipulated by the Jensen and Meckling (1976) agency cost model. Throughout this analysis we consider the role of ownership structure and type on capital structure and firm performance.     

The risk appetite of private equity sponsors

Using a unique proprietary data set of 460 realized buyouts completed between 1990 and 2005, we examine the risk appetite of private equity (PE) sponsors in different states of the PE market and analyze key determinants of deal-level equity risk. We develop a new approach to mathematically model PE investment equity risk based on the Black-Cox default model. We find higher equity volatilities during boom periods. Further, deals conducted by more reputed PE sponsors have lower equity volatilities as they are unwilling to imperil their reputation by taking excessive risks. In addition, we find that PE sponsors' risk appetite is negatively related to the ownership stake in the buyout target company.     

The role of institutional investors in seasoned equity offerings

Do institutional investors possess private information about seasoned equity offerings (SEOs)? If so, do they use this private information to trade in a direction opposite to this information (a manipulative trading role) or in the same direction (an information production role)? We use a large sample of transaction-level institutional trading data to distinguish between these two roles of institutional investors. We explicitly identify institutional SEO allocations for the first time in the literature. We analyze the consequences of the private information possessed by institutional investors for SEO share allocation, institutional trading before and after the SEO and realized trading profitability, and the SEO discount. We find that institutions are able to identify and obtain more allocations in SEOs with better long-run stock returns, they trade in the same direction as their private information, and their post-SEO trading significantly outperforms a naive buy-and-hold trading strategy. Further, more pre-offer institutional net buying and larger institutional SEO allocations are associated with a smaller SEO discount. Overall, our results are consistent with institutions possessing private information about SEOs and with an information production instead of a manipulative trading role for institutional investors in SEOs.     

Interaction of market and credit risk

Experience during the financial crisis illustrates that the integrated measurement and management of different forms of risk remains a challenge for industry practitioners, researchers and financial supervisors alike. In the context of related literature, this article summarizes new research on the interaction of market and credit risk and implications for risk management that is presented in this special issue. The research covered highlights in particular the errors that can occur in the aggregation of the two types of risk and the strong relationships between them that suggest caution in the use of pragmatic distinctions between them. The article also touches on some research-based lessons for supervisory policies and suggests some directions for future research.     

Extending the Basel II approach to estimate capital requirements for equity investments

Under the Basel II banking regulatory capital regime the capital requirements for credit exposures are calculated using the Asymptotic Single Risk Factor (ASRF) approach. The capital requirement is taken to be the contribution of an exposure to the unexpected loss on the bank’s diversified portfolio. Here we extend this approach to calculate capital requirements for equity investments. We show that in the case when asset values have a normal distribution an analytical formula for the unexpected loss contribution may be developed. We show that the capital requirements for equity investments are quite different to those of credit exposures, since equity investments can suffer substantial loss of value even when the underlying company has not defaulted.     

The impact of conglomeration on the option value of equity

Using contingent claims analysis, I quantify the effect of risk-reducing corporate diversification on the value of equity as a call option on firm assets. The impact of conglomeration on firm risk is heavily conditioned on firm size. In contrast to small firms, the risk of large firms does not decline with increasing conglomeration. Accounting for this effect, the expected equity discount is much lower than commonly assumed and can even turn into a premium if the path dependency of equity is incorporated. My results stand in direct contrast to those of Mansi and Reeb (2002) and caution against using asset substitution as a qualitative argument for explaining economy-wide value phenomena.     

Contracting under asymmetric information: Evidence from lockup agreements in seasoned equity offerings

We document the frequent use of lockup agreements in seasoned equity offerings (SEOs) and examine the determinants of their use, duration, and early release. We find that the likelihood of an SEO lockup and its duration are positively related to issuer information asymmetry measures. Lockup duration is negatively related to underwriter spreads and underpricing, indicating that lockups lower expected flotation costs. Lockups are frequently released early following share prices rises. We conclude that lockups represent a contracting solution to asymmetric information and agency problems that plague equity issues by helping to insure SEO quality and deter opportunistic insider trading.     

Correlation dynamics in equity markets: evidence from India

This study is aimed at understanding the correlation dynamics of the equity markets from a developing country perspective using daily data from July 1997 to August 2006. A simple unconditional correlation estimate and dynamic time varying correlation estimate from a DCC-MVGARCH of Engle and Sheppard (2001) are derived for S&P CNX Nifty and other 10 world indices that includes four developed and six Asian country indices. The results show low correlation across S&P CNX Nifty with both Asian and developed nations. In addition a Logistic Smooth Transition Regression (LSTR) model is implemented and finds that the S&P CNX Nifty index is moving towards a better integration with other world markets but not at a very noteworthy phase. The low correlation provides space for the global funds to diversify risk in Indian markets.