Academic journal article Review of Business

Factors That Impact Underpricing of Seasoned Equity Offerings

Academic journal article Review of Business

Factors That Impact Underpricing of Seasoned Equity Offerings

Article excerpt

The main goal of this article is to provide statistical evidence about factors that explain the level of Seasoned Equity Offering (SEO) underpricing. We study a sample of 1,840 Seasoned Equity Offerings (SEO) issued between 2003 and 2011. The most significant contribution of this article is the statistical evidence about a negative relationship between the offer price and SEO underpricing. This relationship might result from the conventional underwriter pricing practice. We report record levels of SEO underpricing never measured before, particularly in the year 2009 when 270 SEOs had an average level of underpricing of 6.86%. We also find that the level of SEO underpricing has dramatically increased since the 2008 financial crisis.

Introduction

The main goal of this article is to analyze some factors that impact the level of Seasoned Equity Offering (SEO) underpricing calculated based on the pre-issue closing price. This is a phenomenon that has intrigued many financial professionals for decades, but no consensus exists about the specific factors that explain this type of underpricing. We analyze 1,840 SEOs issued between 2003 and 2001. Among the firms in our sample, 1,591 SEOs set an offer price different from the last closing price before the SEO date and only 249 firms used such a closing price as the relevant value for the share of stock.

This paper provides statistical evidence about the negative relationship between offer price and SEO underpricing. The lower the offer price, the higher the level of SEO underpricing. Also, we test some factors that impact the probability of underpricing a SEO. Although this is not the first paper to report a negative relationship between offer price and SEO underpricing, to the extent of our knowledge this paper is unique in that it provides statistical evidence on the significant increment of SEO underpricing after the financial crisis of 2008.

Some academic studies have reported and analyzed SEO underpricing. Smith (1977) compares two methods to raise additional equity capital: right offerings versus employing underwriters. He finds that regardless of the clear advantages of right offerings, most firms choose underwritten offerings. Smith studies 328 SEOs listed in the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX) from 1971 to 1975 and finds an average underprice of 0.54%. Parsons and Raviv (1985) propose a model of underwritten offerings of new SEOs where the offering price selected by the investment bank is lower than the market price. They argue that the underwriter must set an SEO price low enough to lure investors with high valuation of the issuer's new investment projects.

Bhagat and Frost (1986) study all primary public offerings of utility companies made from 1973 to 1980. They find an average underpricing level of -0.25%. Loderer, Sheehan, and Kadlec (1991) study 1,608 SEOs from 1980 to 1984. They find an average level of SEO underpricing of -1.41%. These results are driven by the level of SEO underpricing in the NASDAQ market where more than 80% of their SEOs are underpriced. They also find substantial variability in the SEO underpricing with ranges from -25 to +33%. Gerard and Nanda (1993) study the possibility of trading manipulation in SEOs. They argue that informed investors may attempt to influence offering prices by selling shares before the SEO, and profit subsequently from lower prices in the SEO.

Safieddine and Wilhelm (1996) study the nature and magnitude of short-selling activity around SEOs of 474 NYSE and AMEX listed firms In particular, they study the impact of the SEC adoption of the Rule 10b-21 to address concerns about manipulative short-selling practices. Using the close-to-offer return, they find an average SEO underpricing of -0.55% prior to the adoption of Rule 10b-21, and -0.46% after the adoption of such rule. Kim and Shin (2001) study a sample of 3,304 SEOs from 1983 to 1998. …

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