Academic journal article Journal of Financial Management & Analysis

Seasoned Equity Offerings:rights Issue versus Underwritten Commitment : The U.S. Economy in Perspective

Academic journal article Journal of Financial Management & Analysis

Seasoned Equity Offerings:rights Issue versus Underwritten Commitment : The U.S. Economy in Perspective

Article excerpt


In recent times the majority of firms have elected the underwritten commitment Using investment bankers to distribute shares saddles the corporation with higher flotation costs and deprives the pre-equity issuance shareholders of enjoying the inevitable underpricing of the shares. In addition, underwritten issues must be approved by the securities Exchange Commission (sec) in the United States (U.S.A.) causing delays and adding to the cost of raising capital. Furthermore, those investors most inclined to purchase shares of the company would be those who are already owners of the firm. Nonetheless, the number of rights offerings has decreased over time.

This paper explores the impact of seasoned equity offerings, comparing rights to underwritten commitment issues, on the corporation. Three aspects of external equity are studied; ( 1 ) short-term effect on stock returns, (2) long-term stock returns, and (3) operating performance.


Smith1 analyzed the choice of method for raising additional equity capital. Rights offerings had significantly lower costs, yet fewer than 10 per cent of offerings employed this method, preferring instead the use of underwriters. It is suggested that underwriters provide monitoring management which makes underwriting advantageous. White and Lusztig2 found a negative stock return effect from rights offering announcements. Hansen3 showed that U.S. firms conducting underwritten rights offerings incurred greater flotation costs compared to underwritten public offerings primarily because of priced concessions rather than the fees. Eckbo and Masulis4 developed a model of choosing the equity flotation method; the choice is between uninsured rights, rights with standby underwriting, and firm-commitment underwriting. The choice depends on shareholder characteristics, information asymmetries, and direct flotation costs. Uninsured rights have adverse-selection effects whereas underwriter certification reduces these effects.

Hertzel and Smith5 found private equity placements were correlated with positive abnormal returns suggested due to undervaluation signals and anticipated monitoring benefits. Tsangarakis6 analyzed Greek firms, for the period 1981-1990, that issued rights offerings and found contrary evidence, that is, in the announcement period there were statistically significant abnormal positive returns. Moreover, the abnormal returns were associated with the following variables;

* negatively with share ownership diffusion,

* positively with the amount of capital raised relative to existing capital,

* positively with the stock return variance, and

* positively with the growth of the stock market index prior to the offer.

Chan7, from an Australian (1987-1993) sample, reported an increase in volatility in the postannouncement period versus the pre-announcement period (rights offering) and that impacts the analysis of the underpricing phenomenon. Bohren, Eckbo and Michalsen8 with an Oslo Stock Exchange sample found firms are more likely to use standby underwriting when shareholder take-up decreases and that there is positive stock market reaction to uninsured rather than insured rights attributed to the asymmetric information theory. Cai9 showed that Japanese firms raising equity through rights offerings (1971-1986) subsequently suffered in operating performance as well as a decline in stock returns for three years. BaeandJo10 examined the information effect of rights offering announcements and found an increase in trading volume post-announcement date along with a decline in stock price volatility from the preannouncement period to the post-expiration period. Armitage11 found for United Kingdom (U.K.) issuers of rights offerings that the underwriters did not certify value but rather ensured the capital was raised.

Wu12 discovered private placement firms have higher information asymmetry titan public offering firms. Jayanti13 presents empirical data for British and German banks, that underwritten (insured) rights offering cause less of a stock price decline than non-underwritten (uninsured) rights offerings. …

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