Firm Size, Common Stock Offerings, and Announcement Period Returns

By Hull, Robert M.; Mazachek, JuliAnn et al. | Quarterly Journal of Business and Economics, Summer 1998 | Go to article overview

Firm Size, Common Stock Offerings, and Announcement Period Returns


Hull, Robert M., Mazachek, JuliAnn, Ockree, Kanalis A., Quarterly Journal of Business and Economics


Introduction

Prior event period research shows that common stock offerings for small OTC firms have a more negative mean announcement period stock return than do large OTC firms. Most event studies, however, involve samples that include AMEX- and NYSE-listed firms. Thus, there is a need to explore whether the firm size results documented for OTC stock offerings hold for AMEX and NYSE stock offerings.

We extend stock-for-debt studies on several fronts. First, we extend the OTC firm size research of Hull and Pinches (1994/1995) by including AMEX/NYSE observations in our stock-for-debt sample. Prior AMEX/NYSE security offering studies argue for signaling effects but do not link the magnitude of the signaling to firm size.(1) Second, motivated by the work of Hull and Kerchner (1996), we investigate to what extent issue costs can explain differences in stock returns attributable to firm size. If issue costs cannot adequately account for the firm size effect, then there is evidence to support firm size as a proxy for a differential information wealth effect.

Literature Review

In this study we use a sample of pure leverage decrease announcements consisting of stock offerings that retire debt. As first noted by Masulis (1980), such a sample is ideal for examining the stock price impact of a firm's change in its security mix because a pure leverage change varies the mix of the firm's securities without directly altering the productive assets. Thus, any wealth impact from altering production is not present. Those who have investigated stock-for-debt transactions (Masulis, 1983; Cornett and Travlos, 1989; Copeland and Lee, 1991; Hull, 1994; Hull and Moellenberndt, 1994) document statistically significant negative announcement period stock returns. They generally conclude that the market response is consistent with asymmetric information theory predicated on insider signaling (Leland and Pyle, 1977; Ross, 1977; Fama, 1985).(2)

Hull and Pinches (1994/1995) and Hull and Kerchner (1996) recently have offered new insight into explaining the negative returns for stock-for-debt transactions. Hull and Pinches (1994/1995) find that firm size does a better job of accounting for OTC stock returns than do signaling effects (or other wealth effects cited by the extant literature). To the extent firm size proxies for the amount of information activities, their findings are consistent with differential information theory (Wilson, 1975; Atiase, 1980; Verrechia, 1980; Bhushan, 1989). This theory predicts that announcements by small firms reveal more and thus induce greater wealth effects (by magnifying effects from insider signaling). Last, Hull and Pinches (1994/1995) offer some evidence to suggest that a firm size may be attributed to issue-related costs (in addition to differential information).

Hull and Kerchner (1996) analyze the role of issue costs in accounting for OTC/AMEX/NYSE stock offering announcement returns. In their study issue costs comprise cash flotation costs (consisting of the underwriting spread and fees associated with administration, registration, and legal services) and underpricing. They find that issue costs can aid in explaining the negative announcement period return. This is especially true for samples that contain either OTC or AMEX firms. Because issue costs increase as firm size decreases, their findings suggest that support for a firm size effect may be due to issue costs. Like Hull and Pinches (1994/1995), they note collinearity problems when firm size and issue costs variables are used together in regression analysis. The high degree of correlation between these variables prevents regression tests from giving definitive conclusions concerning the role of differential information as proxied by firm size. Both Hull and Pinches (1994/1995) and Hull and Kerchner (1996) leave it to future research to decide the extent that an issue costs effect, as opposed to a differential information effect, explains announcement period returns for stock offerings. …

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