Intended Use of Proceeds, Underwriter Quality and the Long‐run Performance of SEOs in the UK

• Date: 01 November 2015
• DOI: http://doi.org/10.1111/jbfa.12171
• Author: André Silva,Pawel Bilinski
• Published date: 01 November 2015

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 42(9) & (10), 1282–1309, November/December 2015, 0306-686X

doi: 10.1111/jbfa.12171

Intended Use of Proceeds, Underwriter

Quality and the Long-run Performance of

SEOs in the UK

ANDR´

ESILVA AND PAWE L BILINSKI∗

Abstract: We document that prospectus disclosure of (i) the motives for a seasoned equity

offering, and (ii) the choice of underwriter explain the long-run performance of equity issuers

in the UK. Firms citing investment needs show no abnormal performance after the offering

and have higher investment rates post-issue compared to the period before the offering. Issuers

that state general corporate purposes and recapitalisation motives underperform, have similar

investment rates pre- and post-issue, and their leverage tends to increase after the offering.

Further, consistent with the certifying role of underwriters, equity issues underwritten by high-

quality brokers show no evidence of post-issue abnormal returns, but offerings taken public

by low-quality underwriters exhibit negative abnormal performance. Together, our results

document the significant role that prospectus information on the intended use of offering

proceeds and on the underwriter play in predicting issuers post-offering performance in the UK.

Keywords: seasoned equity offerings, post-issue underperformance, use of proceeds, under-

writer quality

1. INTRODUCTION

A vast body of literature documents that seasoned equity offering firms (SEOs)

underperform over 3 to 5 years after the issue.1However, little is known about

how prospectus information on the issue motive and the choice of the underwriter

help investors in predicting SEO post-issue performance, particularly outside the

US market. This lack of evidence is surprising considering that investors are likely

to closely scrutinise prospectus information to judge how the firm intends to use

∗The authors are from Cass Business School, City University London. They thank the Editor (Martin

Walker), an anonymous referee, Franc¸ois Derrien, Meziane Lasfer and seminar participants of the 4th

International FEBS Conference for helpful comments and suggestions. (Paper received December 2014,

revised version accepted November 2015).

Address for correspondence: Andr´

e Silva, Cass Business School, 106 Bunhill Row, London EC1Y 8TZ, UK.

e-mail: andre.silva.3@cass.city.ac.uk

1 Loughran and Ritter (1995) and Spiess and Affleck-Graves (1995) were the first to document SEO

underperformance in the US. Levis (1995) provides early evidence on SEO underperformance in the UK,

which studies by Armitage (2002), Ngatuni et al. (2007), Capstaff and Fletcher (2011) and Balachandran

et al. (2013) corroborate. Massa et al. (2013) use a sample of 69 countries and show negative long-run

returns after right offerings.

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the proceeds since the issuer’s prospects depend on it. Specifically, prospectus

information can help investors separate firms issuing equity to finance value-increasing

investment projects from market-timers that experience disappointing post-offering

returns.

Using a large sample of UK SEOs, this study provides novel evidence that prospectus

information on the intended use of the issue proceeds and on the underwriter predict

SEO post-offering performance. The UK setting offers a unique research laboratory

to test the signalling effect of prospectus information. The most common equity

issuance methods in the UK, such as rights issues, open offers and share placements,

are either first directed to existing shareholders or target a select group of large

institutional investors (Barnes and Walker, 2006; Balachandran et al., 2013). Thus,

in the UK managers have less incentive to produce misleading or uninformative

disclosure such as hiding that the firm is timing the market when compared to the

US setting where offerings to the public dominate (Capstaff and Fletcher, 2011). As a

result, we would expect prospectus information to be useful in predicting SEO post-

issue performance. Surprisingly, Ngatuni et al. (2007, p. 54) report that “[L]ong-term

underperformance is pervasive irrespective of the proposed use of funds”.2Their

evidence is puzzling and suggests prospectus disclosure in the UK is uninformative.

It also contrasts with US results in Walker and Yost (2008) and Autore et al. (2009)

that document that prospectus information helps predict SEO post-offering perfor-

mance. Further, reputational considerations are likely to be particularly important

for UK underwriters as they transact repeatedly with the same group of institutional

investors, particularly for share placements (Barnes and Walker, 2006). Yet, no study

to date has examined if the choice of the underwriter signals SEO prospects in

the UK.

We divide the empirical analysis into two parts. First, we examine SEO performance

split by the intended use of proceeds (i.e., investment, recapitalisation and general

corporate purposes) as disclosed in the offering prospectus. We predict that issuers

disclosing investment needs signal positive NPV projects that require financing and

these SEOs will not underperform after the offering. This prediction follows from

Walker and Yost (2008) and Autore et al. (2009) that suggest that better post-offering

performance of US SEOs that disclose investment needs is justified by the fact that

these firms use proceeds to finance new value-increasing projects. We expect firms

indicating recapitalisation and general corporate purposes to underperform. We base

this prediction on the evidence in Hertzel and Li (2010) who argue that firms issuing

equity for recapitalisation purposes are timing the market. Firms may also mask issues

of overvalued equity by stating vague motives for the offering such as general corporate

purposes.

Empirical results confirm our predictions. Firms stating investment purposes when

issuing new equity do not underperform relative to both size, and size and book-

to-market benchmark firms over 3 years subsequent to the offering. Further, these

SEOs show a 185% increase in investment rates after the offering. These findings

are consistent with these issuers credibly signalling their need for cash to finance

new projects. SEOs reporting general corporate purposes and recapitalisation motives

2 Contrary to our study, Ngatuni et al. (2007) focus on the comparative analysis of post-offering perfor-

mance for UK rights and open offers. Only one table (Table 6) in their study reports SEO performance

split by the intended use of proceeds with the analysis limited to rights issues only. Wecompare our study to

Ngatuni et al. (2007) in detail later in this section.

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