Market Reaction to Seasoned Offerings in China

• Date: 01 May 2016
• Author: Dayong Zhang,Saeed Akbar,Syed Zulfiqar Ali Shah,Jia Liu,Dong Pang
• Published date: 01 May 2016
• DOI: http://doi.org/10.1111/jbfa.12198

Journal of Business Finance & Accounting

Journal of Business Finance & Accounting, 43(5) & (6), 597–653, May/June 2016, 0306-686X

doi: 10.1111/jbfa.12198

Market Reaction to Seasoned Offerings

in China

JIA LIU,SAEED AKBAR,SYED ZULFIQAR ALI SHAH,DAYONG ZHANG

AND DONG PANG∗

Abstract: This study examines stock market reaction to the announcement of various forms

of seasoned issues in China. Our empirical evidence demonstrates that market reactions differ

in ways that suggest a difference between management’s internal assessment and the market’s

assessment of the stock price. The market responds unfavourably to the announcement, notably

in the case of rights issues and also with regard to open offers. Private placements experience

an unfavourable pre-announcement reaction, which contrasts with the favourable reaction

after the event. Convertible bond issues generate positive excess returns consistent with the

market’s confidence that they can help to align management and shareholders’ interests.

Further investigation shows that market reaction is related to factors specific to the issuer and

issue by reference to the period immediately surrounding the issue. Specifically, ownership

concentration, agency matters connected with equity offerings, investor protection connected

with fund allocation and security pricing, and the influence of powerful moneyed interests

together provide an instructive insight into market reaction. Institutional inefficiency pertaining

to underwriting, auditing, analysts’ forecasts and credit ratings are found to have a weak

association with market price, consistent with due public scepticism concerning management

and their gatekeepers.

Keywords: seasoned issues, seasoned equity offerings, convertible bond issues, market reaction,

information, information asymmetry, agency costs, market infrastructure, China

1. INTRODUCTION

Previous studies have examined the firm’s financing decisions and the corresponding

market price movements. Differences in price behaviour appear to depend mainly

on the available information pertaining to forms of financing and the perceptions of

∗The first author is from the University of Salford. The second author is from the University of Liverpool

Management School. The third author is from Warwick Business School at the University of Warwick.

The fourth author is from Southwestern University of Finance and Economics, Chengdu, China. The fifth

author is from the University of Bedfordshire. The authors are very grateful to Roger Lister; the Editor,

Martin Walker; and an anonymous referee for their insightful and constructive comments. The authors also

benefited from comments from participants at the European Economic Association Annual Congress and

British Accounting and Finance Association Annual Conference. (Paper received September 2014, revised

version accepted February 2016).

Address for correspondence: Jia Liu, The University of Salford, The Crescent, Salford, Greater Manchester

M5 4WT, UK.

e-mail: j.liu@salford.ac.uk. The copyright line for this article was changed on 01 August 2016 after original

online publication.

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This is an open access article under the terms of the Creative Commons Attribution License, which permits use,

distribution and reproduction in any medium, provided the original work is properly cited.

598 LIU ET AL.

the market with respect to the firm’s financing decisions (Myers and Majluf, 1984).

Within the body of theory, several studies have considered the market implications

of securities issues to new as opposed to existing investors, and also the types of

issues that are subject to different degrees of regulatory discipline, obligations and

incentives (Baker and Wurgler, 2000; Carlson et al., 2006; DeAngelo et al., 2010; Silva

and Bilinski, 2015; and Hovakimian and Hu, 2016).

Information asymmetries impinge forcefully in terms of the signals conveyed

when securities are issued. The theory of information asymmetries posits that if

managers seek to maximize their existing shareholders’ wealth, shares will be offered

to the existing owners only when the management believe that the firm’s equity is

undervalued (Myers and Majluf, 1984; and Jenter et al., 2011). The price pressure

hypothesis suggests that an unexpected equity issue may also drive down the price

by signalling that the firm must make up for a shortfall in unobservable cash flow

from operations (Fama and French, 2006; Slovin et al., 2000; and Intintoli and Kahle,

2010). The wealth transfer hypothesis proposes that an unexpected issue of equity

reduces the risk of the firm’s outstanding debt leading to a wealth transfer from

shareholders to bondholders with a net value loss for shareholders (Masulis, 1983;

and Elliott et al., 2009). The above foci of discussion have helped to generate interest

in the comparative market reaction to the different forms of security issuance (e.g.,

Barnes and Walker, 2006).

In the case of open offers, a management which favours existing shareholders over

new potential shareholders has an incentive to issue equity when shares are overvalued,

especially when the firm goes public in a hot market (Gomes, 2001; and Alti, 2006).

Issuing new shares increases the number of outsider shares, diluting the ownership

stake and aggravating the potential conflict between managers and outside investors,

and thereby constraining firm value accordingly (Ginglinger et al., 2012). These

impacts are less likely to occur if ownership is already highly concentrated (Slovin

et al., 2000; and Holderness, 2009).

In contrast to open offers, private placements are typically offered to a group of

sophisticated investors whose certification amounts to a positive signal by way of a

quality seal (Wruck, 1989; and Chakraborty and Gantchev, 2013), mitigating under-

valuation problems, and averting the negative signals of public offerings (Hertzel and

Smith, 1993; and Wang, 2012). They may, however, be vulnerable to agency problems

associated with ownership concentration especially when ownership is already low

(Wruck, 1989).

In the case of rights issues, take-up can guard against ownership dilution or

wealth transfer to new shareholders. Hence, rights issues circumvent the agency costs

associated with open offerings by mitigating the impact of asymmetric information

problems and lowering transaction costs (Miller and Rock, 1985; Attig et al., 2006; and

Fama and French, 2006).

Unlike the securities discussed above, convertible bonds entail contractual disci-

plines and constraints. These can serve to allay market concerns that arise in respect

of other forms of issuance, militating against asset substitution and adverse selection

problems associated with plain equity sales (Myers and Majluf, 1984; and Stein, 1992).

Empirical evidence on price effects of equity issues was seminally analysed by

Loughran and Ritter (1995) and Spiess and Affleck-Graves (1995). Subsequently, a

number of other studies have extensively examined mature markets such as the US

(Gao and Ritter, 2010; Henry and Koski, 2010; Alti and Sulaeman, 2012; and Bradley

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MARKET REACTION TO SEASONED OFFERINGS IN CHINA 599

and Yuan, 2013), the UK (Slovin et al., 2000; Capstaff and Fletcher, 2011; Iqbal et al.,

2013; Armitage et al., 2014; and Silva and Bilinski, 2015), France (Ginglinger et al.,

2012), Spain (Mart´

ın-Ugedo, 2003; and Alvarez and Gonzalez, 2005), Japan (Suzuki

and Yamada, 2012), Australia (Lamberto and Rath, 2010), and others. Most of the

recent studies in this area of research have been encouraged to a large extent by

the increased interest in equity issues worldwide. It has been argued that reduced

transaction costs and the globalisation of finance have encouraged firms to acquire

equity finance in global financial markets (Kim and Weisbach, 2008). Research interest

has been further stimulated by recent periods of the marked unpopularity of equity

issues. This has occurred notably since 2000 both in the US and in Europe due, inter

alia, to a tendency to favour merger as a means of rapid growth, and also because of

low market valuation of companies after the collapse of the technology bubble and an

increasingly onerous burden of regulation (Craig et al., 2010; and Gao et al., 2013).

In recent years, security issuance in emerging markets has also attracted research

attention (e.g., La Porta et al., 1999; Chen and Yuan, 2004; Cheng et al., 2006; Ahmad-

Zaluki et al., 2007; Chen and Wang, 2007; and Luo et al., 2010). Findings differ

distinctly across markets as well as overall between emerging and mature settings,

especially when marked differences exist in respect of institutional and operational

arrangements. These differences engender issues based on reputation, relationships

and public policy in supporting financing channels particularly when market maturity

is an aspiration (Allen et al., 2005). China is a notable example here, due to its global

importance and the evolving nature of its capital markets.

The salient characteristics of security issuance in China are consonant with the

country’s evolving social, economic and market status as well as the pervading presence

of powerful influential groups. The research takes due cognisance of important

cultural influences which impinge on market mechanisms. All note agency problems

consistent with an underdeveloped institutional infrastructure that is deficient in

safeguards against informational asymmetries leading to security mispricing, the

deliberate distortion of earnings, and the manipulation of the dividend profile in the

period immediately surrounding security offerings. These abuses can operate to the

detriment of minority investors and other outsiders. For instance, in the case of rights

issues and open offers, the influence of agency costs associated with state ownership

comes to bear. In the case of private placements, there are clearly visible signs of both

manipulation of issue price in the run-up to the issue by the dominant controlling

shareholders and also a propensity to post-issue overinvestment (e.g., Yu et al., 2006).

While acknowledging the progress of the literature on security issuance, there

remains scope for a further investigation and comparison of the distinct influences

that come into play with different methods of issuance. Early work typically focuses

on a single method of issuance for predicting market movements following the

announcement without exploring the relative implications of a range of issuance

methods for investors. A number of studies explore specific types of issue, for instance

open offers (e.g., Slovin et al., 2000; and Barnes and Walker, 2006), rights offers (e.g.,

Mart´

ın-Ugedo, 2003), private placements (e.g., Barclay et al., 2007) and convertible

bonds (e.g., de Jong et al., 2011; and Lewis and Verwijmeren, 2014). However,these fall

short of offering a comparative perspective of the range of influence on market price

exercised by the different methods of issuance. Control and discipline matters should

be taken into account, including management’s ex-ante issue motives and decisions

associated with different methods of issuance.

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2016 The Authors Journal of Business Finance & Accounting Published by John Wiley & Sons Ltd