Are share price reactions to rights offerings sensitive to different economic conditions?

AuthorAriff, M.
PositionReport

ABSTRACT

This study examines short-term stock price reactions to announcements of equity rights offerings in Singapore between 1983 and 2003 and investigates whether economic factors lead to different price reactions. The results show that the cumulative abnormal returns (CARs) associated with rights issues differ significantly across economic conditions at the time of issuance. Rights issues typically result in significantly large positive CARs during periods of economic growth but small positive but insignificant CARs during economic downturns. The CARs vary positively with Tobin's q-ratios, which indicate the availability of positive net present value investment opportunities of the firms issuing the rights. Our major finding is that the price reaction of Singapore firms to equity rights offerings is sensitive to economic conditions at the time of the rights issues.

Keywords: Equity Rights Offers, Economic Effect, Capitalization Effect, Rights In Developing Markets

INTRODUCTION

The market response to news of equity rights offerings differs substantially across countries. In countries with developed capital markets and large ownership dispersion such as the United States, the stock price reaction is generally negative. In countries with less developed capital markets and large ownership concentration such as Greece, Italy, Singapore, and Turkey, the reaction to rights offerings, which is the primary method of raising equity by seasoned firms in these countries, is consistently large and positive. The varied evidence on the price reaction to rights offerings may reflect different economic conditions and other characteristics of the associated countries. The failure to fully identify why the disparity in share price reaction to rights offerings exists across countries makes further research potentially useful.

This study investigates the magnitude and sign of the common stock price reaction to announcements of rights offerings in Singapore by exploring economic factors as potentially differentiating the price reaction. A rights offer occurs when a company with publicly traded stock issues additional shares to existing shareholders only. The main purposes of rights are to preserve the control position of existing stockholders and to protect stockholders against the dilution of ownership. In our study, the fear of dilution is not an issue because cash offers are unavailable under the exchange regulations in Singapore. To our knowledge, no empirical investigations have examined the price effects of rights offerings in Singapore as conditional on economic situations at the time of rights offerings.

We address two major research questions. First, how does the market respond to announcements of rights issues in Singapore? We hypothesize that the risk-adjusted abnormal returns (ARs) associated with rights issue announcements differ significantly from zero. Second, does the price reaction associated with the announcement of rights offerings differ between periods of economic growth and downturn? We hypothesize that the cumulative abnormal returns (CARs) associated with the announcement of rights offerings differ significantly between the two economic periods.

Our study updates and refines the limited research on equity rights offerings using Singapore data. First, our test period of 19832003 spans two business cycles and includes the 1997-1998 financial crisis and subsequent recovery. Second, unlike previous studies in Singapore (Dawson 1984, Ariff and Finn 1989, and Tan, Chang, and Tong 2002), we remove confounding events such as announcements of dividends, earnings, mergers, or capitalization-change events that occurred during the test windows. Third, we use a proxy to identify the availability of positive net present value (NPV) opportunities by using the Tobin's q-ratio to enable us to condition the price effect under different economic situations.

We limit the scope of our study in several ways. First, we focus on short-run price reactions to rights offerings. Unlike some studies (Shaw 1971, Barber and Lyon 1996, Loughran and Ritter 1997, Pastor-Llorca and Martin-Ugedo 2004), we do not examine long-run performance. These studies consistently find that the long-run performance is inferior, but the performance in the year before the rights issue is good. A study of long-run performance would require a separate effort due to differences in methodology and data requirements. Second, we concentrate on testing whether economic conditions can help to explain the share price reactions to rights offerings in Singapore. Although we do not explicitly test other rationales, our results have implications involving information effects.

Finally, we do not partition our sample into underwritten and non-underwritten rights offerings and hence, do not investigate the method of offer. Rights offerings in the U.S. may or may not be underwritten. Miles and Peterson (2002) study a large sample of non-underwritten offers in the U.S. Tan, Chang, and Tong (2002) suggest that underwritings represent most rights offerings in Singapore. Further partitioning of our sample by type of rights issue could affect our statistical analysis due to the small numbers of cases that are likely to be non-underwritten issues.

The remainder of the paper has the following structure. The next section provides a brief background of the Singapore Exchange (SGX) and listing requirements. The third section provides a summary of selected international evidence on the price effects of rights offerings. In addition, this section provides several explanations for the observed differences in the price reaction to announcements of rights offerings in various countries. The fourth section describes the data sources, research methodology, and test procedures. The fifth section presents the empirical results, and the final section provides concluding comments.

BACKGROUND ON THE SINGAPORE EXCHANGE

The SGX is Asia-Pacific's first demutualized and integrated securities and derivatives exchange. The inauguration of the SGX took place on December 1, 1999, following the merger of the Stock Exchange of Singapore (SES) and the Singapore International Monetary Exchange (SIMEX). Although the SGX is relatively new, its origin extends back many years. Modernization of the original exchange occurred in 1960 as the exchange for the Federation of Malaya (later Malaysia) and the state of Singapore. In 1973, with the cessation of common currency arrangement for two countries, the shares began to trade in two currencies--the Malaysian Ringgit in Kuala Lumpur and the dollar in Singapore.

In the 1980s, companies incorporated in Malaysia were required to cease trading on the old exchange. Its predecessor, the "SES," permitted more listing of local companies and some foreign companies from such countries as Thailand and China. With the delisting of a large number of Malaysian shares, the SGX became less risky, and its characteristics changed markedly. The capitalization of this market in 2003 was S$383 billion (US$215 billion) with 415 listings. Individuals hold most shares and dominate trades.

The SGX consists of a Main Board listing and a SESDAQ listing. The listing requirements changed over the 1983-2003 study period, with amendments in 1999. For a Main Board listing, Singapore and foreign incorporated companies are subject to the same requirements. A company may apply for a Main Board listing based on any one of three alternative criteria, which involve differences in the amount of pre-tax profit or capitalization and continuity of management. The prescribed minimum percentage of shares that must be held by public investors is determined by reference to the market capitalization of the issuer based on the issue price. Main Board companies must have a minimum of 1,000 public shareholders.

Listing on SESDAQ is open to both Singapore and foreign incorporated companies. There are no minimum requirements in respect of share capital, profit, or operating record. No less than 500 public shareholders must hold at least 500,000 shares or 15% of the issued and paid-up capital, whichever is the greater.

RELATED LITERATURE

This section provides an overview of selected international studies on the market reaction to announcements of rights offerings. We also discuss several possible explanations for the differences in abnormal stock returns associated with such announcements

EVIDENCE FROM SELECTED STUDIES

The empirical evidence involving rights issues in the U.S. is generally negative. For example, Scholes (1972), who investigates the period 1926-1966, finds that stock prices generally increase before the rights issue, fall during the month of the issue, but remain unchanged after the issue. Smith (1977) reports a negative but insignificant average abnormal return during the month of a rights offering. White and Lusztig (1980), Hansen (1988), Eckbo and Masulis (1992), and Bae and Jo (1999) document a negative reaction to announcements of rights offers.

Several studies in the U.K. offer mixed results. For example, Marsh (1979) reports a positive price effect at the time of rights offers during 1962-1975, a high-growth period. By contrast, Wolfe, Daliakopoulos, and Gwilym (1999) report a significant negative price reaction to the announcement dates of rights issues. Slovin, Sushka, and Lai (2000) show that rights offerings in the U.K. characterized by high shareholder participation do not affect firm value, while rights offerings that elicit lower shareholder participation have significantly negative announcement effects.

Several non-U.S. studies generally report a positive stock price response to the announcement of rights offerings, especially in less developed and high growth economies. Loderer and Zimmermann (1988) investigate rights offerings in Switzerland and report insignificant average abnormal returns using monthly data. Other studies provide evidence of a non-negative price...

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