Determinants of discounts in equity rights issues: An international comparison

• Author: Astrid Salzmann,Nils Bobenhausen,Wolfgang Breuer
• Date: 01 April 2020
• DOI: http://doi.org/10.1002/rfe.1073
• Published date: 01 April 2020

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wileyonlinelibrary.com/journal/rfe Rev Financ Econ. 2020;38:300–320.

© 2019 University of New Orleans

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INTRODUCTION

Multiple studies have been conducted to measure and understand the announcement effect of equity issues on stock prices.

Yet, few articles address rights issues, probably because equity issues via rights offerings play a minor role in the dominating

U.S. market. Furthermore, existing studies about rights issues in different countries focus almost exclusively on measuring and

explaining their announcement effects, but very little attention is paid to explaining the discount on an equity rights issue. This

study aims to close this gap. We define the discount on an equity rights offering as the difference between the subscription price

and the stock price one day prior to the announcement of the equity rights issue in relation to the stock price one day prior to

the announcement.

Recent studies in the finance literature have highlighted that behavioral and cultural factors play a major role in understand-

ing financial decision‐making. Kwok and Tadesse (2006), for example, show that the level of uncertainty avoidance can help

to explain whether the financial system in a certain country is more likely to be bank or market based. Moreover, Beugelsdijk

and Frijns (2010) point out that culture is an important determinant of the foreign bias in international asset allocation. Besides

offer‐ and firm‐specific variables, cultural aspects should thus contribute to our understanding of what influences the choice of

discounts in a rights offering.

Several existing theoretical models explain the choice of discounts and predict announcement effects for equity rights of-

ferings. In particular, Heinkel and Schwartz (1986) and Breuer (2008) develop such theoretical models. Based on these two

Received: 21 January 2019

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Revised: 7 June 2019

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Accepted: 19 June 2019

DOI: 10.1002/rfe.1073

ORIGINAL ARTICLE

Determinants of discounts in equity rights issues: An

international comparison

NilsBobenhausen

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WolfgangBreuer

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AstridSalzmann

Department of Finance,RWTH Aachen

University, Aachen, Germany

Correspondence

Nils Bobenhausen, RWTH Aachen

University, Department of Finance,

Templergraben 64, 52056 Aachen,

Germany.

Email: nils.bobenhausen@bfw.rwth-

aachen.de

Abstract

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 lit-

tle 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 exist-

ing 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 ex-

plaining 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.

KEYWORDS

discount, equity rights offering, uncertainty avoidance

JEL CLASSIFICATION

G15; G32; G40

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BOBENHAUSEN Et Al.

theoretical approaches, we derive hypotheses regarding the determinants of discounts and test them in a multivariate regression

approach.

Our study detects evidence that a higher level of uncertainty avoidance on the country level leads to lower discounts in an

equity rights issue. With the level of uncertainty avoidance as a proxy for loss aversion, this negative relation was anticipated

in the literature (Breuer, 2008). In addition, we can also show that high quality firms choose ceteris paribus lower discounts,

which is in line with the theoretical model developed by Heinkel and Schwartz (1986). Furthermore, firms with highly volatile

stock returns prefer higher discounts. Singh (1997) supports this empirical finding. Additionally, we perform an analysis which

reveals that the effect of uncertainty avoidance on discounts depends on the level of investor protection in a certain country.

Robustness checks substantiate the significance of our results. To the best of our knowledge, the relevance of uncertainty avoid-

ance for discounts on equity rights offers has not been tested before. Our international dataset allows us to account for such

country‐specific effects.

This paper is organized as follows: In Section 2, we review previous theoretical literature about equity offerings and develop

our hypotheses, while we describe previous empirical literature in Section 3. We introduce the data and our methodology in

Section 4 and demonstrate our empirical results along with several robustness checks in Section 5. Section 6 presents additional

analyses, and Section 7 concludes this paper.

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THEORETICAL BACKGROUND AND HYPOTHESES DEVELOPMENT

In this section, we review theoretical connections between the main variable Discount and some key parameters and develop

our hypotheses in the subsequent second part.

2.1

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General properties of the discount

As mentioned in Section 1, we define the discount DC formally as:

with P−1 being the stock price at time t=−1, that is, immediately prior to the announcement of the equity rights issue at time t=0,

and PS as the subscription price.

At the announcement of an equity rights issue, one right is attached to each existing share prior to the offering. We denote the

number of old shares prior to the offering as m and the number of new shares offered as n. To participate in the offer and to buy

new shares at the subscription price PS,

m∕n

rights are needed to buy one new share. This allocation ratio (AR) has a direct impact

on the discount. If we assume that a firm plans to raise a fixed investment outlay I via an equity rights issue, we can calculate I by

multiplying the number of new shares with the subscription price. Therefore, the subscription price can be written as:

With

AR =m∕n

, we get from Equation (2):

Inserting Equation (3) into Equation (1) leads to:

Equation (4) demonstrates a negative relation between AR and DC. A higher allocation ratio (which is equivalent to a lower n)

leads to a lower discount for a given investment amount I. Equation (2) explains this negative relation, as a higher value for AR, and

(1)

DC

=

P

−1

−P

S

P

−1

,

(2)

P

S=

I

n.

(3)

P

S=

I×AR

m.

(4)

DC

=

P−1−

I×AR

m

P

−1

=1−I×AR

m×P

−1

.