Information Content of Offer Date Revelations: A Fresh Look at Seasoned Equity Offerings

• Author: Konan Chan,Ajai K. Singh,Wen Yu,Nandkumar Nayar
• Date: 01 September 2018
• Published date: 01 September 2018
• DOI: http://doi.org/10.1111/fima.12186

Information Content of Offer Date

Revelations: A Fresh Look at Seasoned

Equity Offerings

Konan Chan, Nandkumar Nayar, Ajai K. Singh, and Wen Yu∗

Besides the offer price discount, investment bankers use revisions in offer size from the amount

originally filed to signal the issuer’s quality to their buy-side clients. Unlike the offer price

discount, offer size revision not only relatesto the offer date price reaction, it also predicts post-

SEO (seasoned equity offering) performance.Improved SEOs, whose offer size exceeds the amount

originally registered, experience significantly positive returns during the registration period and

on the offer date. More importantly, they do not underperform post-issuance. Their complement,

regular SEOs, exhibit significantly negative returns during the registration period, on the offer

date, and underperform their benchmark followingissuance.

Prior research has paid scant attention to the seasoned equity offering (SEO) registration period,

the market’s reception to the issuer’s road show, and the final offer size relative to the amount

filed initially.1An examination of these elements, within the context of our Amended Proceeds

Hypothesis, yields new insights into the market’s reaction and associated valuation consequences.

The hypothesis, as discussed in detail later, is based on the framework originally presented in

Galloway et al. (1998), to which we introduce a specific role for the investment banker.

Weposit that investment bankers (IB) serve a unique role in the SEO process in their interaction

with both the issuers (their sell-side clients) and the institutional investors (their buy-side clients).

Specifically, the IB has to toe a delicate line, balancing loyalty to her buy-side clients, while

providing optimal service to her sell-side clients, with her reputation on the line as an intermediary

in the market place with both sides of the transaction.2The IB shares the issuer’s information with

her buy-side clients during the SEO’s road show. The buy-side clients integrate this information

into their own assessment of the issuer to formulate indications of interest and to trade in the

Wethank Marc Lipson (Editor) and an anonymous referee, for their constructive comments and helpful suggestions. We

are indebted to Mike Lemmon and Jay Ritter for comments on earlierdrafts of this manuscript. We thank Jodie Hu and

Pei-shanTung for research assistance. Partof the work was completed when Chan was at University of Hong Kong.Chan

acknowledges the financial support from the General Research Fund (GRF 741608 H) offered by the Research Grants

Council of Hong Kong. Nayar is grateful forf inancial support fromthe Hans Julius B ¨

ar Chair. Part of the work on this

paper ensued when Nayar was with the US Securities and ExchangeCommission (SEC). This study expresses the authors’

views and does not necessarily reflect those of the SEC, the Commissioners, or other members of the SEC staff. Singh

gratefully acknowledgesthe f inancial support fromthe Bolton-Perella Chair while he was at Lehigh University and from

the SunTrust endowment in his currenttenure at the University of Central Florida. Any errors or omissions in this study

are solely the responsibility of the authors.

∗Konan Chan is a Professorin the Department of Finance at National Chengchi University in Taiwan.Nandkumar Nayar

is a Professor in the Perella Department of Finance at Lehigh University in Bethlehem, PA. Ajai K. Singh is a Professor

in the Department of Finance at the University of Central Florida in Orlando, FL. Wen Yu is an Associate Professor of

Accounting in the Opus College of Business at the University of St. Thomas in TwinCities, MN.

1Exceptions are Phelps and Kremer (1992) and Galloway, Loderer, and Sheehan (1998) who examine revisions in the

number of shares offered in the SEO and not in the size of the proceeds.

2Wethank the anonymous referee for guiding our discussion along this line of reasoning.

Financial Management •Fall 2018 •pages 519 – 552

520 Financial Management rFall 2018

secondary market for the issuer’s stock. The IB, in turn, synthesizes the information contained

in both the aggregated indications of interest, as well as the price movement in the stock, to

determine the offer price and the number of shares issued. Thus, the final offer size decision is

influenced by the informational exchange between the issuer,the IB, and her prospective buy-side

investors and the associated stock price reaction during the SEO’s registration period.3

Accordingly, the final offer size decision includes important information content about the

quality and the post-issuance performance of the issuer. Bona fide offers raise more capital than

initially filed. Conversely, if the offer is perceived to be weak, the banker keeps the offer size

below the filed amount.

In line with our hypothesis, we construct an ex ante measure that classifies an observation as

an “Improved” SEO if the final offer proceeds exceed the amount initially filed at registration.

Additionally, any observation with a post-effective amendment, designated by the SEC as an

MEF filing, is also classified as an Improved offer.4The complement of an Improved offer is

defined as a “Regular” SEO. This classification yields an ex ante measure relative to the issuers’

post-SEO performance, as it identifies each observation as Improved or Regular as soon as the

offer size is finalized on the offer date.

As noted above, the Improved set of issuers includes a subsample of firms who file a post-

effective amendment to increase the offer size, designated by the SEC as an MEF filing. Of

the 232 MEF filings in our sample, there are 24 observations whose final offer size is slightly

below the amount originally filed. These 24 observations could arguably be classified as Regular

SEOs. We find that our results are robust to this alternate classification. It is our contention

(corroborated through discussions with investment bankers) that MEF amendments are filed to

accommodate unexpected demand that surfaces after the offer has become effective.It is possible

that undecided buy-side investors make a late decision to apply for more shares once the offer

price is revealed. It is also conceivable that investors who are already included in the “pot” make

a bid to get more shares than their original indication of interest to the investment banker. The

market infers that the MEF filings represent unexpectedly strong demand from the investment

banker’s buy-side clients and responds accordingly.

Consistent with the view above, we record a significantly positive offer date price reaction

for Improved MEF offers. We find that the offer date reaction to the Improved offerings range

from significantly positive (for Improved MEF offers)to nonnegative for the non-MEF Improved

SEOs. In sharp contrast, the offer date price reactions are significantly negative for the Regular

offers. We are the first to report the offer date price reaction associated with MEF amendments.

It must be noted that within the Improved SEOs, although the MEF observations have a

significantly positive price reaction on the offer date, the average cumulative returns from the

second day following the SEO’s filing to the day before the offer date are relatively higher and

significantly more positive for the non-MEF Improved offers. It does not appear to be a case of

3The registration period is the interim between the SEO’s filing with the Securities and Exchange Commission (SEC)

and the offer date. Issuers and their investment banks conduct the offer’s road showduring the SEO’s registration period.

On the offer date, the offer price (and,hence, the offer price discount) and the offer size are revealed.

4The offering is considered effective when filed documents are complete with signatures from the different parties to

the firm commitment contract including all transaction details, such as the offer price and the gross underwriting spread.

The MEF amendment is filed on the offer date only after the original registration has become effective, and allows the

issuer to raise a maximum of an additional 20% of the effective amount. In a majority of cases, the MEF amendment

is filed under a distinct and separate filing number from the offer’s original filing. The final prospectus bears both the

original and the MEF file numbers and, consequently, the offersize specified in the final prospectus includes the extra

amount arising from the MEF amendment. It is important to note that not all post-effective amendments are MEF filings.

POSAM filings are also post-effective amendments. However,they are usually filed to reduce (i.e., deregister) the number

of shares already registered by the firm.

Chan et al. rInformation Content of Offer Date Revelations 521

gamesmanship where the MEF filers hold back their positive information until after the offer

becomes effective. We argue that there is no need to hide the good news as there is no guarantee

that investor demand will actuallymaterialize after the SEO becomes effective. Thus, for the post-

issuance analyses, the Improved offers are treated as a single composite group, which includes

both MEF and non-MEF Improved SEOs. The long-term performance of the Improved issuers is

compared against the performance of those firms making Regular offers.

In our analyses, we employan indicator variable to distinguish Improved/Regular observations.

Wealso construct a continuous variable that measures the degree of revision in the final offer size,

increase or decrease, relative to the amount initially filed. Wef ind that both the indicator variable

and, particularly, the degree of revision in the final offer size have significant valuation implica-

tions on the offer date and beyond. Regular offers significantly underperform their benchmark

in the post-issuance period, while Improved offers do not. The difference in post-issue returns

between the Improved and Regular offers is statistically significant and ranges from 0.55% to

0.69% per month depending upon the method employed. In addition, Regular SEOs experience

deteriorating fundamentals, while Improved issuers make relatively larger investments following

their SEOs. These results are consistent with the Amended Proceeds Hypothesis.

In addition to identifying the valuation effectsof the post-effective MEF amendments, this paper

makes another significant contribution to the literature. Altınkılıc¸ and Hansen (2003) propose the

use of the unexpected offer price discount by the investment banker as a signal to her buy-side

clients. Our parsimonious ex ante classification into Improved and Regular issuers provides a

richer information measure than the offer price discount. Specifically, while both the unexpected

offer price discount and the Improved classification are related to the short-term price reaction

on the offer date, only the latter is associated with the long-term performance of the issuer.

The rest of the paper is organized as follows. Section I discusses the literature and our Amended

Proceeds Hypothesis. Section II describes the sample and summary statistics. In Section III, we

present announcement, registration period, and offer-date marketreactions for the different types

of SEOs. Section IV discusses the long-run stock returns. Section V contains the robustness checks

including an examination of the operating performance and changes in the issuers’ investments

in the post-SEO period. Our conclusions are contained in Section VI.

I. Literature Review and the Amended Proceeds Hypothesis

A. Literature Review

SEOs typically follow a stock price run-up, and their announcements evokea signif icantly neg-

ative stock price reaction (Asquith and Mullins, 1986; Masulis and Korwar, 1986). While these

stylized facts are well established,there is considerable debate concerning the motivation underly-

ing SEOs. The market timing hypothesis argues that managers exploit windowsof oppor tunity to

sell overvalued stock. Forexample, Myers and Majluf (1984) suggest that the SEO announcement

itself reveals to the market that the issuers’ stock is overvalued. Lucas and McDonald (1990)

argue that undervalued firms wait for a stock price run-up before issuing additional equity, while

overvalued firms issue equity immediately upon the arrival of a value enhancing project. In Lucas

and McDonald (1990), the arrival of value enhancing projects is independent of the firm’s price

history and the firm needs the proceeds from the SEO to invest in these projects. The overvalued

firms issue equity immediately upon the arrival of the positive net present value (NPV) project,

while the undervalued firms wait for the undervaluation to “vanish” before issuing additional

equity.