Academic journal article Financial Management

Issue Costs and Common Stock Offerings

Academic journal article Financial Management

Issue Costs and Common Stock Offerings

Article excerpt

Prior research of common stock offerings reaches different conclusions concerning the impact of issue costs on stock value. We identify factors that can best explain the different findings--most prominent are the issue costs measure and the listing. We investigate 323 common stock offerings and find that $61 of every $100 fall in stock value can be attributed to issue costs. The respective dollar amounts for the samples of OTC, AMEX, and NYSE firms are $72, $69, and $38. These findings suggest that the collective impact of the negative wealth effects from managerial signaling may be less important than generally assumed.

* Mikkelson and Partch (1986) and Hull and Fortin (1993/1994) are the only studies to examine in detail the impact of issue costs on announcement period stock returns for equity offerings. These two studies reach different conclusions. Mikkelson and Partch (1986) find that offering costs are a relatively small portion of the negative announcement period return, while Hull and Fortin (1993/1994) show otherwise. This disagreement motivates our research as we aim to explain the different conclusions concerning the wealth impact of issue costs, in the process we hope to understand the situations for which issue costs can significantly impact common stock value.

We begin our research by examining the literature in order to discover factors that can help explain the different conclusions. We identify four potentially relevant factors: the measure of issue costs; the listing of the firms in the sample; the percentage change in outstanding common stock caused by the new offering; and the inclusion or exclusion of combination offerings.

We select a sample of 323 common stock offerings and investigate this sample in light of the above four factors. First, we use (for the most part) an issue costs measure that is a compromise between those used by the two prior studies. This measure includes cash flotation costs (consisting of the underwriting spread and fees associated with administration, registration, and legal services) and underpricing. The use of the term "cash" captures the fact that these costs cause an immediate cash compensation for investment bankers. Second, in our analysis, we include an examination of samples of OTC (n=106), AMEX (n= 107), and NYSE (n=110) firms. Third, we screen out issues that involve very small changes in common shares (and for which an issue costs effect is not of economic significance). Finally, we investigate both primary and combination offerings.(1)

We summarize our results when cash flotation costs and underpricing are used to measure issue costs. When testing our total sample, we find that the average fall in common share value that can be attributed to issue costs is -1.59%, as compared to the average two-day fall in stock value of -2.62%. The mean fall in stock value represents 61% of the mean fall in stock value. Thus, if we compare averages, about $61 of every $100 fall in stock value can be accounted for by issue costs. The dollar amounts for the OTC, AMEX, and NYSE samples are $72, $69, and $38 for every $100 fall in value, respectively. We also show that the dollar amounts (per $100 fall) are greater when we analyze samples where the percentage change in common stock is greater or where combination offerings are excluded.

Finally, we perform tests after adjusting announcement period returns for the negative effect caused by issue costs. Although these adjusted returns remain negative even after removing the negative issue expenses effect, we find that these returns are no longer significantly different from zero for either the OTC or AMEX sample. These insignificant results appear to suggest that negative wealth effects typically cited by the literature (e.g., signaling, agency, and tax effects) may not be present for OTC and AMEX firms. However, these results do not necessarily rule out a variety of negative effects for individual announcements, but only serve to highlight the possibility that these negative effects might be on average, neutralized by positive wealth effects. …

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