Academic journal article Financial Management

Long-Term Performance of Seasoned Equity Offerings: Benchmark Errors and Biases in Expectations

Academic journal article Financial Management

Long-Term Performance of Seasoned Equity Offerings: Benchmark Errors and Biases in Expectations

Article excerpt

Narasimhan Jegadeesh [*]

I investigate the long-term performance of firms that issue seasoned equity relative to a variety of benchmarks. I find that these firms significantly underperform all of my benchmarks over the five years following the equity issues. Across SEOs, I find similar levels of underperformance for both small firms and large firms, and both growth firms and value firms. The paper also shows that factor-model benchmarks are misspecified. Hence inferences on SEO underperformance based on such benchmarks are misleading. I also find that SEOs underperform their benchmarks by twice as much within earnings announcement windows as they do outside these windows.

Many recent studies examine the long-term performance of stocks following important corporate events, such as initial public offerings, seasoned equity offerings, stock repurchases, stock splits, dividend initiations and omissions, and privatizations. [1] These studies report that stock prices systematically drift up or down relative to their benchmarks for up to five years following the events. One interpretation of the results in these studies is that capital markets do not efficiently value the information conveyed by many important corporate announcements. Also, these results imply that traditional event studies over short windows around the events capture only a small portion of the impact of corporate actions on firm values.

I address several issues related to long-term performance of seasoned equity offerings (SEOs). First, I evaluate the sensitivity of SEO underperformance to the choice of benchmarks. There is strong and well-accepted earlier evidence that firms that issue seasoned equity have low longterm returns relative to the market index. However, the interpretation that seasoned equity issues convey new information to the market that the issuer is steeply overvalued, and that the market ignores this information, is controversial. An alternative interpretation, proposed forcefully by Fama (1998) and others, argues that low returns for these firms are not related to the act of issuing seasoned equity per se, but to cross-sectional relations between characteristics of SEOs, such as their low market-to-book ratios and high past returns, and future returns. Put differently, this interpretation implies that SEOs may appear to perform poorly only because they are not evaluated against the correct benchmark.

In this paper, I consider various benchmarks for firms that issue seasoned equity. My benchmarks include the equal- and value-weighted indexes, benchmarks constructed based on firm-specific characteristics, and factor-model benchmarks. The characteristics of the SEOs that are matched by the characteristic-matched benchmarks are firm size, market-to-book ratio, earnings-to-price ratio, lagged six-month return, and lagged 36-month return. I choose these characteristics for two reasons. First, previous studies show that these characteristics are related to future stock returns. Second, firms that issue seasoned equity do not represent a random sample, but have values of these characteristics that are systematically different from those of other publicly traded stocks.

I find that the evidence of SEO underperformance is robust, and that it survives the best candidates for benchmark returns. Across various benchmarks, I find the lowest level of SEO underperformance when the benchmark simultaneously matches on size and market-to-book ratio. The results are not sensitive to benchmarks that match SEOs on additional characteristics, such as earnings-to-price ratios and past returns. Furthermore, large-firm SEOs underperform by about the same extent as do small-firm SEOs, and growth-firm SEOs underperform by about the same extent as do value-firm SEOs. In contrast, some recent papers (e.g. Bray, Geczy, and Gompers, 2000) find larger underperformance for small-firm SEOs than for large-firm SEOs when measured against factor-model benchmarks. …

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