Sources of Corporate Financing and Operating Performance: The effects of strategic ownership and financial restatements

Using a sample from European markets this study documents that changes in external financing, both in the form of equity and debt, can predict future operating performance (profitability and cash flows). In terms of future profitability, increases in equity (debt) financing particularly benefit large-size growth firms (large-size value firms). It is notable that a firm environment of low information quality, indicated by the presence of accounting restatements, intensifies the association between external financing and operating performance, due to the heightened scrutiny investors/lenders apply to firms that have recently restated their financials. In addition, strategic ownership in the firm has no significant effect on the financing – operating profitability association but may amplify the positive effects of equity financing on future operating cash flows. Moreover, financial analysts' forecasts of operating profitability and operating cash flows reflect the impact of external financing changes on future operating performance but exhibit a financing-related systematic inefficiency particularly for firms that have recently announced a material restatement of their prior financial results. Finally, controlling for information contained in analyst forecast surprises, the market is efficient overall and incorporates the effects of equity and debt financing changes into stock prices.     

Putable common stock

The underpricing of initial public offerings is a well-documented phenomenon in the financial literature. The purpose of this paper is to show how this empirical regularity could be solved by an appropriate choice of financing instruments, namely, by an intelligent mix of common stocks and put options. The latter additional instrument, modeled in this paper as a lump sum paid by insiders of the firm to outsiders, helps alleviate the asymmetry of information existing between insiders and outsiders of the corporation, allowing good firms to sell the package they offer at the full information value.     

Is sustainability rating material to the market?

This study examines whether information about a firm's engagement in environmental, social, and governance (ESG) practices is material to market participants. Evidence from a sample of 1856 initial public offerings (IPOs) by U.S. companies for the 2007–2018 period robustly documents that firms for which there is available ESG performance information prior to going public exhibit higher underpricing due to a positive market response. Such a reaction is validated by agency cost-reducing practices that ESG-rated firms follow prior to the IPO, the superior post-IPO market performance they exhibit in terms of equity financing, and the higher share of financially sophisticated investors they attract compared to their ESG-unrated peers. Overall, our results highlight that it pays off to do good and to have the right investors; however, firms’ good ESG practices need to be visible to the market, through rating practices, to reap the benefits.     

The IPO and first seasoned equity sale: Issue proceeds,owner/managers' wealth,and the underpricing signal

Recent models of IPO underpricing suggest that high-quality firms underprice their IPOs to differentiate themselves from low-quality firms and, thus, receive a more favorable market response to subsequent equity offerings. We test this suggestion for 172 industrial firms that made an initial public offering during 1987–1991 and made a subsequent seasoned equity offering within three years of their IPO. We examine two measures of the impact of the hypothesized underpricing signal net of the cost of employing that signal. Inconsistent with the underpricing signal hypothesis, we find no evidence that firms recover the cost of an underpriced IPO in either higher issue proceeds or in greater wealth for the firm's initial owners.     

An Empirical Examination of the Pricing of Seasoned Equity Offerings: A Test of the Signaling Hypothesis

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 offerings 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.     

A Test of the Signaling Value of IPO Underpricing with REIT IPO-SEO Pairs

The asymmetric information hypothesis states that IPO underpricing signals superior firm value. During the post-IPO period, the market learns the firms true worth such that good quality firms issue seasoned equity at favorable prices and recoup the loss sustained at IPO. Since REITs have no special incentive to issue debt because of their tax-exempt status, and since they must pay out 95 percent of net income as dividends, REIT managers are hard pressed to raise capital through seasoned equity. Consequently, the signaling link between IPOs and SEOs is critical for REITs. Consistent with the signaling model, we find strong evidence that (1) REITs that underprice IPOs more are likely to sell seasoned equity sooner, (2) higher IPO underpricing results in larger joint amount of capital raised through an IPO-SEO pair, and (3) firms that underprice IPOs underprice SEOs as well. IPO underpricing does not mitigate the valuation loss associated with seasoned offerings, however.     

IPO activity and information in secondary market prices

This paper explores the link between IPO underpricing and financial markets. In my model the IPO is a mean for a capital constrained initial investor to exit and thereby to raise funds for a new investment opportunity. This investor is privately informed vis-a-vis outside investors about the profitability of the new opportunity and the quality of the firm to be offered in the IPO. He can then use the offer price and the fraction of shares sold as signals of his private information. The model shows that underpricing is not only linked to firm’s characteristics, i.e. firm value, but to elements external to the firm, i.e. new investment profitability and financial markets characteristics. In particular higher market efficiency reduces the cost of listing. This results in lower underpricing and the listing of more valuable firm. Similarly, a higher lower bound of the new investment’s profitability reduces the information asymmetry and hence reduces underpricing and widens the range of firms listed.     

The effect of securities litigation on external financing

Using a comprehensive sample of securities litigation, we examine the effect of financial fraud on the subsequent use of external financing. We find that firms with a recent history of securities litigation, particularly more severe litigation, are less likely to seek external debt and equity financing. This negative relationship between prior litigation and external financing is stronger for firms with high information asymmetry. Furthermore, firms significantly reduce their investments in capital expenditures and research and development during the three years following a litigation filing. Thus, the reduction in the availability of external financing due to allegations of financial fraud can have a tangible impact upon the investment opportunities of the firm.     

THE UNDERPRICING OF “SECOND” INITIAL PUBLIC OFFERINGS

The underpricing of initial public offerings (IPOs) of equity represents a well-documented empirical phenomenon. One prominent explanation for this underpricing relies on the uncertainty investors feel about the value of the issuer. In this paper, this asymmetric information hypothesis is tested by examining the underpricing of IPOs of seventy-four firms for which the uncertainty about the value of the firm is likely to be substantially reduced. These firms were once publicly owned, then taken private, and subsequently returned to public ownership. Findings show that the IPOs of these “reverse leveraged buyouts” are significantly less underpriced than typical IPOs. These results support the asymmetric information hypothesis.     

Underpricing in the Corporate Bond Market

This article examines underpricing of initial public offerings(IPOs) and seasoned offerings in the corporate bond market.We investigate whether underpricing represents a solution toan information problem or a liquidity problem. We find thatunderpricing occurs with both IPOs and seasoned offerings andis highest among riskier, unknown firms. Our evidence suggeststhat information problems drive underpricing, with support forboth the bookbuilding view of underpricing and the asymmetricinformation theory. We do not find evidence in favor of theRock model of underpricing or any evidence that illiquiditycauses underpricing.     

The Stock Market and the Financing of Corporate Growth in Africa: The Case of Ghana

This paper examines corporate financing patterns in Ghana, in particular, whether listed Ghanaian corporations make considerable use of the stock market to finance their growth. The paper also examines econometrically the effect of stock market development on the importance of debt relative to external equity in the balance sheet of Ghanaian firms. The results show that the average listed Ghanaian firm finances its growth mainly from short-term debt. The stock market, however, is the most important source of longterm external finance. Stock market development tends to shift the financial structure of Ghanaian firms toward more equity and less debt. Overall, the evidence suggests that the stock market is a surprisingly important source of finance for funding corporate growth.     

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.     

External financing and earnings management: Evidence from international data

Corporate financing conditions in the external capital market are significantly affected by information asymmetry, while internal financing is not. Given that earnings information influences market perceptions regarding firms’ quality, firms relying on external financing should have incentives to manage earnings to improve their financing conditions. This study investigates the effect of corporate external financing behavior on earnings management. Using a sample comprising 75,790 observations of 12,874 firms in 43 countries, we find that accrual-based and real earnings management are positively associated with firms’ reliance on external financing. This positive relationship holds especially true for firms that rely on equity rather than debt financing. We argue that reliance on external financing (especially equity financing), which is subject to problems arising from information asymmetry, generates a motive for earnings management.     

The Pricing of Initial Public Offerings: A Dynamic Model with Information Production

This paper presents an information-theoretic model of IPO pricing in which insiders sell stock in both the IPO and the secondary market, have private information about their firm's prospects, and outsiders may engage in costly information production about the firm. High-value firms, knowing they are going to pool with low-value firms, induce outsiders to engage in information production by underpricing, which compensates outsiders for the cost of producing information. The information is reflected in the secondary market price of equity, giving a higher expected stock price for high-value firms.     

Signaling in the Internet craze of initial public offerings

We explain the clustering of underpricing in initial public offerings (IPOs). The model features an industry with aggregate demand uncertainty and asymmetric information about firms' quality. In the IPO market, firms can signal quality by underpricing or under-issuing new shares. Expected aggregate demand for the industry's products increases with the publicity that the industry creates through IPO underpricing. We show that asymmetric information and expectations on aggregate product demand interact with each other to generate multiple equilibria. Underpriced IPOs cluster in one equilibrium but not in the other. We use these results to explain why the clustering often occurs in particular industries, is short-lived, and is sensitive to economic conditions.     

SUSTAINABLE GROWTH AND CHOICE OF FINANCING: A TEST OF THE PECKING ORDER HYPOTHESIS

This paper studies the impact of sales growth above a sustainable level on the financing choices of the firm. Myers [1984] indicates that firms typically employ a pecking order of financing choices, using internal equity before the issuance of external debt, followed by the issuance of external equity. Contingency table analysis performed in this paper provides indirect evidence that the faster firms are growing, the more they use up available internal financing and, thus, must raise funds externally. In addition, logit analysis shows that firms with lower asymmetric information tend to raise the majority of their funds externally, with debt being the primary choice. Together, both sets of results provide indirect support for Myers' pecking order theory since it appears that firms use available internal financing, then debt, then new equity to finance growth.     

Financing Decisions along a Firm’s Life‐cycle: Debt as a Commitment Device

We analyse the life‐cycle patterns of a firm’s financing decisions and their interaction with future growth and development decisions. We derive different financing sequences which we link to existing empirical research as well as derive new testable hypotheses regarding differences in firms’ financing decisions to project, firm, market and country characteristics. We provide a rationale for the importance of (external) start‐up debt financing as observed in recent empirical studies. Furthermore, we argue that equity financing at both development stages is more likely for closely‐held firms and in countries in which entrepreneurs face high stigmatisation costs.     

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.     

Does financing influence the sensitivity of cash and investment to asset tangibility?

Research shows that asset tangibility substantially impacts firms’ cash levels and investment. Using the deregulation of equity issuance in the U.S. as an exogenous shock to access to equity markets, we investigate the influence of financing on the dependence of cash and investment on asset tangibility. We show that financing dampens the sensitivity of cash and investment to asset tangibility, and promotes investment and firm growth. Our results suggest that greater access to financing allows financially constrained firms to invest in productive projects that may otherwise not be taken up. This provides evidence that public firms even in well-developed financial markets such as the U.S. benefit from financial deregulation that removes barriers to external financing, shedding light on the role of financial markets in fostering growth.     

IPO Prospectus Information and Subsequent Performance

Initial public offerings underperform in the long run; however, there is very little evidence on their cross‐sectional variation. Using a random sample of IPOs from 1987 through 1991 and gathering their prospectus data, we show that financial and operating characteristics as well as offering characteristics have a limited relation with the one‐year stock returns. We also find that firms that subsequently reissue equity or merge outperform their matched‐firm benchmarks over three years. Underperformance is most severe for the smaller and younger firms. We find that prospectus information is more useful to predict survival/failure compared to subsequent equity offerings or acquisitions.