Alternative flotation methods, adverse selection, and ownership structure: evidence from seasoned equity issuance in the U.K.

Journal of Financial Economics 57 (2000) 157}190

Alternative #otation methods, adverse selection, and ownership structure: evidence from seasoned equity issuance in the U.K.夽 M.B. Slovin 
, M.E. Sushka
*, K.W.L. Lai College of Business Administration, Louisiana State University, Baton Rouge, LA 70803, USA
HEC School of Management, Paris, France College of Business, Arizona State University, Tempe, AZ 85287, USA Department of Accounting and Finance, Lingnan University, Tuen Mun, Hong Kong Received 8 March 1996; received in revised form 26 October 1999

Abstract We examine valuation e!ects of announcements of seasoned equity issuance and assess the impact of the choice of #otation method in the U.K. Rights o!erings are predominant, but in 1986, British "rms gained the #exibility to conduct placings, which are comparable to U.S. "rm commitment o!erings. A placing is a "xed-price bought deal that increases ownership dispersion. Placings generate signi"cantly positive share price e!ects, whereas rights o!erings have large negative valuation e!ects that become more adverse after 1985. We conclude that the option to conduct placings enhances the ability of "rms to signal their quality and to use a seasoned equity o!ering to reduce ownership concentration.  2000 Elsevier Science S.A. All rights reserved. JEL classixcation: G24; G32; G15 Keywords: Equity issuance; Flotation method; Rights o!erings; Placings; Ownership concentration

夽 We are appreciative for the valuable suggestions and insights provided by Jarrad Harford (the referee). We also acknowledge the useful comments of G. William Schwert (the editor). This paper has bene"tted from suggestions from colleagues and seminars at Louisiana State University, HEC, Paris, Hong Kong Polytechnic University, ESSEC, and University of Paris, IX.

* Corresponding author. Tel.: #1-480-965-6581; fax: #1-480-965-8539. E-mail address: [email protected] (M.E. Sushka). 0304-405X/00/$ - see front matter  2000 Elsevier Science S.A. All rights reserved. PII: S 0 3 0 4 - 4 0 5 X ( 0 0 ) 0 0 0 5 4 - 4

158

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

1. Introduction We examine valuation e!ects for alternative methods of #otation at announcements of seasoned equity issuance in the United Kingdom. Our objective is to assess whether share price responses in the U.K. are consistent with contemporary "nance theory and with empirical results for seasoned equity o!erings in the United States. Our evidence indicates that alternative #otation methods have di!erential e!ects on "rm value and that choice of #otation method conveys a di!erent signal in the U.K. than in the U.S. Changes in London Stock Exchange regulations adopted in 1986 broadened the choice of #otation methods available to "rms to raise seasoned equity. This increased #exibility enhanced the ability of British "rms to use their choice of #otation method to signal "rm quality and to alter "rm ownership concentration. Research on seasoned equity issuance focuses on American corporations conducting "rm commitment public o!erings. This o!ering strategy is the dominant #otation method in the U.S. Empirical studies document signi"cantly negative announcement returns, indicating that equity issuance conveys unfavorable information about "rm value. A rights o!ering is an alternative #otation method that allows current shareholders to purchase shares pro rata, that is, proportionate to their existing ownership position, at a speci"ed exercise price until a designated expiration date. In a standby, or insured, rights o!ering, an underwriter guarantees to purchase any unsubscribed shares at the expiration date. An uninsured rights o!ering does not have a standby commitment. Based on U.S. data, rights o!erings have lower direct costs than "rm commitment o!erings (Smith, 1977) and generate negative, but modest, announcement returns. Nevertheless, rights o!erings have been rare in the U.S. since the early 1980s (Eckbo and Masulis, 1992), and in the 1960s and 1970s comprised less than "ve percent of the seasoned equity issued by "rms listed on the NYSE or Amex (Smith, 1977). In the U.K., prior to the mid-1980s, rights o!erings were e!ectively the only method of issuing seasoned equity. In the mid-1980s, deregulation allowed British "rms to conduct placings, a non-rights method of #otation in which an underwriter purchases an equity o!ering from the issuing "rm on the spot at a "xed price, and sells the shares to clients, typically institutions, and other outside investors. A placing is not a private placement, but a form of public securities issuance comparable to a "rm commitment o!ering in the U.S. Insured rights o!erings constitute a majority of seasoned equity issuance in the U.K., with placings the next most common method. In the U.K., there are few uninsured rights o!erings. We examine a sample of British "rms that issue primary seasoned equity through insured rights, uninsured rights, and placings over a post-deregulation period, 1986 to mid-1994. We also analyze a sample of insured rights o!erings over a pre-deregulation period, 1982}1985, to gauge the e!ects of allowing placings as an alternative #otation method. Event study methodology and

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

159

cross-sectional regressions are used to assess the impact of o!ering and issuing "rm characteristics on shareholder wealth. Our results indicate that rights o!erings by British "rms are a negative signal of "rm value, and entail large indirect costs. For the 1986}1994 period, there is a statistically signi"cant two-day average excess return of !2.9% for British "rms, which is similar to the !2% to !3% returns documented for U.S. "rm commitment o!erings, and more unfavorable than the !1% returns observed for U.S. insured rights o!erings. The two-day return for British uninsured rights o!erings is a statistically signi"cant !5%, considerably more unfavorable than returns for U.S. uninsured rights o!erings. Placings generate a signi"cantly positive two-day excess return of 3.3%, which is contrary to the negative returns reported for U.S. "rm commitment o!erings. For the pre-deregulation period, insured rights o!erings have a two-day average excess return of !1.9%, which is statistically signi"cant, but less adverse than in the post-deregulation period. Our results suggest that after 1985, the decision by a British "rm to avoid a rights o!ering, together with the willingness of an underwriter to commit funds to the "rm on the spot through a placing, is a favorable signal of value. Thus, the option to use a placing as an alternative #otation method facilitates self-selection of highquality "rms seeking external "nancing. For insured rights o!erings in the 1986}1994 period, we "nd that subscription price discount is a negative signal of "rm value. Consistent with the model presented in Eckbo and Masulis (1992), we "nd that the share price e!ect is directly related to shareholder take-up, which is the proportion of the o!ering &taken up' or purchased by shareholders of the "rm. Also, we "nd that share price is negatively a!ected when a blockholder renounces take-up of its share allocation. In contrast, prior to 1986, subscription price discount, shareholder take-up, and blockholder renunciation have no e!ect on share price response. For placings, the lower the spread, that is, the higher the price the issuing "rm receives, and the larger the o!ering, the more positive the share price response. Firms that conduct placings typically have greater ownership concentration than "rms that conduct rights o!erings. Since a placing entails the sale of shares to outside investors, there is a decline in ownership concentration, which enhances the potential for external monitoring and corporate control activity. In contrast, a rights o!erings is directed to existing shareholders and take-up is generally high, so there is little change in ownership concentration. We conclude that underwriter certi"cation and monitoring, and the reduction in ownership concentration intrinsic to a placing, o!set the adverse selection and underinvestment problems associated with seasoned equity issuance (Myers and Majluf, 1984). Given the similarity of American and British corporate "nance, di!erences in the practices used in each country to price and market seasoned equity provide a setting that facilitates an examination of the e!ects of equity issuance and

160

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

adverse selection on "rm value. In the U.S., o!erings must be registered with the Securities and Exchange Commission (SEC). After the o!ering is approved by the SEC, the "nal o!er price and size are set just prior to the actual issuance date. Between the initial announcement, when a price range and o!er size are proposed, and the issuance date, underwriters gather information through bookbuilding activities, which include roadshows, that is, presentations to potential institutional investors, and the solicitation of nonbinding indications of investor interest. Thus, o!er price and size can be adjusted, or the o!ering can be withdrawn, subsequent to the initial announcement. This #exibility mitigates the weight of underwriter certi"cation in the U.S. In comparison, in the U.K., the o!ering terms are de"nitive at the initial announcement. Therefore, underwriters can use only pre-announcement information to determine method of #otation, o!ering price, o!ering size, and other o!ering characteristics. In the U.K., a placing is a bought deal in which an underwriter commits to acquire the entire o!ering on the spot at a "xed price, and cannot subsequently withdraw or postpone the o!ering, nor alter the terms of the o!ering. As a result, an issuing "rm gains certainty of proceeds, at the likely cost of lower proceeds, while the underwriter incurs the risk of post-announcement adverse changes in share prices. This practice strengthens the weight of underwriter certi"cation associated with a placing in the U.K. In terms of empirical analysis, investment banking practices in the U.K. imply that share price responses at initial announcements of seasoned equity o!erings, whether rights o!erings or placings, re#ect the market's assessment of all o!ering characteristics. Positive excess returns to announcements of placings indicate that a highquality British "rm can use a placing to distinguish itself from other "rms seeking to raise external equity. Thus, evidence from the U.K. indicates that adverse selection is an important element in #otation choice, but the evidence is not consistent with existing theoretical models. Heinkel and Schwartz (1986) and Eckbo and Masulis (1992) predict that non-rights equity issuance conveys more unfavorable information than rights o!erings. The higher indirect cost of rights o!erings relative to placings in the U.K. is opposite to "ndings for rights versus "rm commitment o!erings in the U.S., suggesting that British placings re#ect greater underwriter certi"cation than occurs with U.S. "rm commitment o!erings. We also "nd that placings generate greater positive returns for "rms with concentrated ownership, indicating that placings enhance "rm value by increasing ownership dispersion and the potential for external monitoring. This result is consistent with Kothare's (1997) hypothesis that "rm commitment o!erings dominate rights o!erings in the U.S. because they improve stock liquidity by reducing ownership concentration. The study proceeds as follows. Descriptions of methods of #otation and underwriting practices in the U.K. are found in Section 2. Hypotheses and the results of previous empirical studies are discussed in Section 3. Sample development and methodology are described in Section 4. Section 5 contains empirical

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

161

results of event studies and cross-sectional regressions. Conclusions are in Section 6.

2. Alternative 6otation methods in the U.K.: rights o4erings and placings The similarity of U.K. and U.S. "nancial structures re#ects a common legal and economic heritage. Each nation has a well-developed equity market that fosters trading, monitors managerial activities, facilitates access to external "nancing, and encourages corporate control activity. Prior to the mid-1980s, the London Stock Exchange, the principal forum for trading securities in the U.K., e!ectively mandated pre-emption, which is the right of shareholders to subscribe to new shares on a pro rata basis. As part of deregulation in 1986, the Stock Exchange provided for the waiver of pre-emption rights to allow placings, a form of seasoned equity issuance comparable to U.S. "rm commitment o!erings. A placing is a "xed-price o!ering in which an underwriter acquires shares directly from an issuing "rm, and then sells the shares to outside investors, primarily institutions, without a commission. A placing is priced and contracted for simultaneously, so the issued shares are the responsibility of the underwriter. Since o!er price and size are set at the initial announcement, underwriting risk for a placing in the U.K. is greater than for a "rm commitment o!ering in the U.S. In the U.S., o!er price and size are "nalized after SEC approval is obtained, which occurs well after the initial announcement. Between the initial announcement and the o!er date in the U.S., an underwriter solicits nonbinding indications of investor interest and conducts roadshows. Through these bookbuilding activities the underwriter gathers information about investor demand, market conditions, and issuing "rm value. Moreover, an o!ering can be postponed or withdrawn after the initial announcement. Mikkelson and Partch (1986, 1988) report that 10% of seasoned equity o!erings in the U.S. were withdrawn between 1974 and 1983. The ability of an underwriter to conduct bookbuilding and to withdraw an o!ering lessens the underwriter certi"cation conveyed in the initial announcement. In the U.K., at the initial announcement of a placing, the underwriter becomes responsible for furnishing the contracted funds, net of the underwriting spread, to the issuing "rm. Thus, the issuing "rm receives a de"nitive price at the time of the announcement, and also gains more rapid, assured access to funds relative to a rights o!ering or to a U.S. bookbuilt-type o!ering. In a placing, the underwriter has no de"nitive information about the market's response to news of the o!ering, cannot subsequently alter the proceeds to the issuing "rm, and cannot cancel the o!ering. As a result, the underwriter is exposed to risk from subsequent adverse share price changes. Underwriters in the U.K. face a greater potential penalty from mis-valuing a "rm compared to underwriters participating in a "rm commitment o!ering in the U.S.

162

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

Investment banks in the U.K. periodically take informal soundings about the portfolio preferences and cash positions of their clients. This information facilitates making decisions about whether to underwrite an o!ering and what price to set. The underwriter's reputation and e!ectiveness at establishing a price and issue size that permit the o!ering to be sold at a pro"t are related to its ability to maintain channels through which it can gather relevant information. Clients expect access to placings at a favorable price, and will be reluctant to participate in the o!ering if they believe shares will be cheaper in the after market. Since the typical underwriter has considerable reputational and "nancial capital at risk, it is unlikely to underwrite a placing unless it is con"dent the o!ering will be successful. Di!erences in the role of underwriters imply that a placing in the U.K. provides a greater degree of certi"cation of issuing "rm value than a "rm commitment announcement in the U.S. Thus, high-quality "rms have an incentive to adopt the placing method of #otation to mitigate the adverse selection problem intrinsic to seasoned equity issuance. In the U.S., under SEC Rule 415, a "rm can conduct a bought deal that is similar to a U.K. placing if it has previously "led a shelf registration. However, this practice is uncommon (Lee et al., 1996; Wall Street Journal, January 9, 1996, p. A7A) and the o!ering may be anticipated by the market due to the shelf registration. With regard to rights o!erings, exercise price is typically set at a discount to pre-announcement share price. In the U.K., a rights o!ering announcement reports all o!er terms, whereas in the U.S., the exercise price is "nalized just prior to the subscription period. In the U.K., shareholders have approximately three weeks from the initial announcement to decide whether to take up their allotment of rights, and rights are actively traded on the Stock Exchange prior to expiration. The rump, that is, rights that have value and are neither exercised nor traded during the subscription period, is sold in the market by a broker appointed by the issuing "rm, with the proceeds credited to the non-exercising shareholders, not to the "rm or the underwriter. By comparison, the secondary market for rights in the U.S. is sporadic (Hansen et al., 1986; Hansen, 1988) and there is no mechanism to compensate shareholders who do not exercise or sell their rights. At the end of the subscription period, any shares not taken up devolve upon the underwriter at the exercise price. In the U.K., the underwriter receives a "xed fee, known as the standby fee, for incurring the risk that the o!ering may fail. In the U.S., the issuing "rm pays the underwriter a standby fee plus a take-up fee for each share not taken up. Anecdotal evidence suggests that standby fees for rights o!erings in the U.K. are relatively uniform (The Economist, October 26, 1991, p. 97). As a result, underwriter compensation focuses on o!er terms since the probability the ex rights price, that is, the prevailing market price for shares without the rights, will fall below the exercise price is altered by varying the subscription discount. From this perspective, the exercise price, as reported in the initial announcement, incorporates perceptions held by the underwriter and corporate managers

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

163

about "rm quality and the risk to the underwriter. This perspective implies that the subscription price discount could have a negative e!ect on "rm value. Since the exercise price can be set su$ciently below the "rm's share price, so as to make it unlikely that the rights will be worthless at the expiration date, a steep discount can be viewed as an alternative to a standby commitment. In principle, setting a low exercise price should not diminish the wealth of existing shareholders since the market value of the rights should change in tandem with the ex rights share price (Brealey and Myers, 1984). For uninsured rights o!erings in the U.K., direct costs are low, and are limited to Stock Exchange fees, postage and printing, and the stamp tax. These modest costs are consistent with Smith's (1977) "nding that rights o!erings in the U.S. have lower direct costs than "rm commitment o!erings.

3. Theory and evidence about choice of 6otation method Rights o!erings are rare in the U.S., so sample sizes are small. Based on such samples, negative share price e!ects are reported by White and Lusztig (1980), at !1.03%; Hansen (1988), at !2.61%; Eckbo and Masulis (1992), at !1.39%; and Singh (1997), at !1.07%. These valuation e!ects are less unfavorable than the negative share price e!ects at "rm commitment o!erings documented by Mikkelson and Partch (1986), at !3.6%; Masulis and Korwar (1986), at !3.3%; and Asquith and Mullins (1986), at !2.7%. Smith (1977) argues that "rms incur the greater #otation costs of "rm commitment o!erings due to side bene"ts that "rm managers receive from underwriters, re#ecting a con#ict between shareholder and managerial interests. The asymmetric information model presented in Heinkel and Schwartz (1986) predicts that "rm commitment o!erings are selected by low-quality "rms, given that the shares are sold to outside investors. Thus, "rm commitment o!erings should generate the most unfavorable share price reaction among #otation methods. Between the two types of rights o!erings, higher-quality "rms select insured rights, which entail underwriter investigation, and thus should generate the least unfavorable share price reaction among #otation methods. Heinkel and Schwartz contend that subscription price is irrelevant because the cost of standby agreements is set in a competitive market. However, "rms that select uninsured rights use subscription price to di!erentiate quality, since the "rm absorbs penalty costs if an o!ering fails. Thus, a lower-quality "rm adopts a lower exercise price, or greater discount, due to the higher probability that unfavorable information will become public after the o!ering is announced, while a "rm with favorable information adopts a higher exercise price, or smaller discount. Eckbo and Masulis (1992) contend that managers and shareholders have asymmetric information about "rm value that in#uences expectations about the

164

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

willingness of existing shareholders to participate in an equity o!ering, which determines #otation method. Managers expecting low shareholder participation choose "rm commitment o!erings and retain underwriters to certify "rm quality. Eckbo and Masulis argue that, since certi"cation is intrinsically noisy, underwriters provide only partial certi"cation of "rm quality. As a result, investors infer an adverse selection problem and bid the share price down. If shareholders are e!ective monitors and a cost-e$cient source of "nancing, managers of undervalued "rms issue uninsured rights, since they expect the o!ered shares to be fully taken up. Under this scenario, since no shares are expected to be sold to outside investors, there should be no adverse selection problem and no adverse market reaction to an uninsured rights o!ering. Insured rights are selected by "rms with an expected shareholder take-up that is greater than that expected by "rms that adopt the "rm commitment method, but lower than the take-up expected by "rms that choose uninsured rights. As a result, announcement e!ects of insured rights should be more unfavorable than uninsured rights, but not as unfavorable as "rm commitment o!erings. In this model, the terms of a rights o!ering are irrelevant. Eckbo and Masulis "nd share price e!ects of U.S. equity o!erings that are consistent with their model. Bohren et al. (1997) examine rights o!erings in Norway, where "rm commitment o!erings do not occur, and "nd uninsured rights generate negative returns that are not statistically signi"cant, while insured rights elicit signi"cantly positive returns. Eckbo and Masulis (1992) "nd that subscription price discount does not a!ect o!ering day returns for either insured or uninsured rights o!erings, but Singh (1997) "nds a weakly negative e!ect. Rights o!erings and placings have di!erential e!ects on "rm ownership structure. Assuming a high take-up, a rights o!ering generally leaves the "rm's ownership concentration unaltered. A placing reduces ownership concentration because shares are sold to institutions and other outside investors. Fama and Jensen (1983), DeAngelo and DeAngelo (1985), and Stulz (1988) contend that high insider ownership facilitates managerial entrenchment and limits the probability of control bids, reducing "rm value. Morck et al. (1988) and McConnell and Servaes (1990) "nd that increased insider ownership enhances value for "rms with low levels of ownership concentration, but reduces value for "rms with moderate to high levels of concentration. Brennan and Franks (1997) argue that initial public o!erings (IPOs) are underpriced to induce oversubscription, which permits underwriters to ration new shareholdings and thus limit concentration. Underwriters of placings may take a similar approach to the distribution of shares to encourage ownership dispersion. Kothare (1997) contends that "rm commitment o!erings, which reduce ownership concentration, bene"t shareholders by enhancing stock liquidity, whereas rights o!erings maintain or increase concentration. Since investors require compensation for trading costs, greater liquidity implies narrower bid}ask spreads and higher "rm value.

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

165

Marsh (1979, 1980) examines direct costs for U.K. rights o!erings, the only major form of equity issuance in Britain at the time of his study. He reports that rights o!erings are almost universally insured and, using option pricing analysis, "nds that standby fees are excessive. Marsh concludes that the market for standby rights o!erings is less than perfectly competitive. Since a "rm can set an exercise price su$ciently low to essentially guarantee the success of an uninsured rights o!ering without incurring standby fees, Marsh's work does not explain the prevalence of insured rights o!erings. The Heinkel and Schwartz (1986) and Eckbo and Masulis (1992) models predict that rights o!erings should have less unfavorable announcement e!ects than "rm commitment o!erings. However, the paucity and vintage of samples of U.S. rights o!erings make it di$cult to obtain a de"nitive assessment of the relative e!ects of alternative #otation methods. We address issues raised about choice of #otation method by studying seasoned equity issuance in the U.K., where placings as well as rights o!erings have been marketed since the mid1980s. We analyze a sample of insured rights o!erings prior to the mid-1980s to provide further insight as to how valuation e!ects are a!ected by increased #exibility of #otation choice. Since o!ering terms are reported in initial announcements, British data provide an opportunity to analyze the e!ects of the subscription price discount, as well as other characteristics of both equity o!erings and issuing "rms, on share price response.

4. Sample and methodology We "rst examine a sample of announcements of rights o!erings and placings of common stock during the period 1986 to mid-1994 by British "rms that trade on the London Stock Exchange and have data reported in the Extel International Financial Data Base. The Extel database begins in 1986, and provides limited coverage of equity issuance prior to the 1990s. Therefore, only a small number of equity o!erings can be documented between 1986 and 1989. We also examine a benchmark, or control, sample of equity o!erings from 1982 to 1985, a period when rights o!erings were e!ectively the only #otation method available to British "rms. This sample is generated from the Financial Times index, which lists rights o!erings as a speci"c index category until 1987. Daily stock price data are obtained from Datastream. For the post-deregulation sample, we use the Extel database and the indexes and articles from the Financial Times and Times (London) to obtain "rst announcement dates. Excluding secondary and joint issues, and limiting the analysis to events with publicly identi"able announcements by British "rms with su$cient daily stock price data to conduct an event study, we obtain a sample of 220 rights o!erings and 76 placings. Of the rights o!erings, 200 are insured and 20 are uninsured o!erings. A broad range of "rms is represented in our sample,

166

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

although there are no eligible o!erings by utilities, which were state-owned during most of the period. Descriptive information about o!erings and issuing "rms is collected from Moody's (International) Manuals, the Yearbook of the London Stock Exchange, the Extel database, the Financial Times, the Times (London), and the Dow Jones News Retrieval Service. In Panel A of Table 1, the distribution of events indicates that insured rights are the dominant #otation method. Uninsured rights are uncommon, con"rming Marsh's (1979, 1980) observation that rights o!erings in the U.K. almost uniformly have standby commitments. Descriptive statistics are reported in Panel B of Table 1. For insured rights, mean gross proceeds are C73.6 million, and median proceeds are C27.5 million. For U.S. "rms, Mikkelson and Partch (1986) report mean gross proceeds for Table 1 Descriptive statistics for seasoned equity o!erings by British "rms, 1986}1994 Descriptive statistics for seasoned equity o!erings by British "rms listed on the London Stock Exchange over the period 1986 through mid-1994, disaggregated by o!er type. The discount is calculated as (P !P )/P , for which P is the exercise price and P is the closing share price \  \  \ the day before the initial announcement. The data are taken from the Extel International Financial Data Base, the Moody's (International) Manuals, the Yearbook of the London Stock Exchange, the Financial Times, the Times (London), and the Dow Jones News Retrieval Service. Panel A: Frequency distribution of seasoned equity issuance announcements

1994 1993 1992 1991 1990 1989 1988 1987 1986 Total

Insured rights

Uninsured rights

Placings

57 78 22 25 9 3 2 2 2 200

1 2 1 0 1 0 4 6 5 20

8 35 14 6 4 3 2 4 0 76

Panel B: Characteristics of seasoned equity owerings and issuing xrms Insured rights

Gross proceeds (Cm) Firm market value (Cm) Gross proceeds/market value Discount (%) Take-up (%) Fees/gross proceeds (%)

Mean

Median

Mean

Median

Mean

Median

73.6 324.2 0.4 17.0 84.4 4.6

27.5 111.1 0.2 15.9 92.0 3.3

112.4 602.6 0.3 28.1 81.7 0.4

34.9 115.5 0.3 26.5 94.6 0.4

18.3 114.5 0.7 * * 6.1

8.7 22.2 0.3 * * 5.2

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

167

"rm commitment o!erings of $39 million, and median gross proceeds of $24 million. Eckbo and Masulis (1992) report mean gross proceeds of $60.4 million, with median gross proceeds of $21.6 million for insured rights o!erings in the U.S. Given exchange rates and in#ation for the periods covered by these samples, British insured rights o!erings on average are larger than U.S. seasoned equity o!erings. Issuing "rms have a mean market value of C324.2 million, and median market value of C111.1 million. The mean ratio of gross proceeds to market value for British insured rights o!erings is 0.4, and the median ratio is 0.2. Insured rights are issued at a mean discount of 17.0% to pre-announcement share price, with a median value of 15.9%. Since the exercise price in the U.S. is not established until the start of the subscription period, the discount in U.S. studies is measured relative to share price the day before the subscription period. For this price, Eckbo and Masulis report a mean discount of 20.4%, and a median discount of 19.5%. In the U.K. sample, mean take-up is 84.4%, with a median take-up of 92.0%. Eckbo and Masulis report that take-up is uniformly close to 100% for U.S. "rms, and Singh (1997) reports a mean take-up of 81%, and a median of 83%, after deducting underwriter purchases. The mean ratio of fees to issue size is 4.6%, with a median of 3.3%. This level is similar to U.S. insured rights, since Eckbo and Masulis (1992) and Hansen (1988) report mean #otation expense ratios of 4.0%. Thus, despite the low risk of failure, there are considerable costs to insuring rights o!erings in the U.K. For uninsured rights o!erings, mean gross proceeds are C112.4 million, although median proceeds are C34.9 million, which are somewhat larger than British insured rights o!erings. The average gross proceeds for uninsured rights o!erings are substantially larger than U.S. uninsured rights o!erings, given the mean gross proceeds of $15.1 million, with median proceeds at $8.6 million, reported by Eckbo and Masulis. Issuing "rm mean market capitalization is C602.6 million, re#ecting a small number of large "rms, since median capitalization, C115.5 million, is similar to the insured rights sample. The mean and median ratios of gross proceeds to "rm market value are 0.3. Fees are low relative to gross proceeds, with a mean and median of 0.4%, re#ecting the absence of standby fees. Exercise price relative to pre-announcement market price implies a mean discount of 28.1%, which is signi"cantly greater than for insured rights o!erings (p"0.07). This level, and the close proximity of the median value at 26.5%, suggests that a large discount is a substitute for a standby commitment. Mean take-up is 81.7%, and the median take-up is 94.6%, which are similar to the take-up for insured rights o!erings. Given the greater discount for uninsured relative to insured rights o!erings, but the similar rates of shareholder take-up, we conclude that British data do not support Eckbo and Masulis's prediction that uninsured rights o!erings are adopted by "rms with higher expected shareholder take-up than insured rights o!erings. For placings, mean gross proceeds are C18.3 million, which are signi"cantly smaller than for insured and uninsured rights o!erings (p"0.00). Median gross

168

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

proceeds are lower, at C8.7 million, indicating that proceeds for placings are similar in size to "rm commitment o!erings in the U.S. (Mikkelson and Partch, 1986). Mean capitalization of "rms is C114.5 million, which is signi"cantly smaller than British "rms that conduct rights o!erings (p"0.00). Median "rm capitalization is only C22.2 million. The mean ratio of gross proceeds to "rm market value is 0.7, and the median ratio is 0.3. The mean ratio of fees to proceeds, or the underwriter spread, is 6.1%, while the median spread is 5.2%. These direct costs are signi"cantly greater than for rights o!erings (p"0.01). Spreads for U.K. placings are almost identical to spreads for U.S. "rm commitment o!erings reported by Eckbo and Masulis. As reported in Table 2, control group and institutional holdings are greater for British "rms that conduct placings rather than undertake rights o!erings, a pattern contrary to that reported by Kothare (1997) for U.S. "rms. Mean control group ownership is 14.7% for insured rights o!erings, and 23.0% for placings, with median values of 6.1% and 16.8%, respectively. Institutional ownership has a mean of 28.4% for "rms that issue insured rights, and 33.9% for placings, with median values of 10.7% and 29.5%, respectively. Share price reactions to seasoned equity o!erings are measured by calculating average prediction errors using the market model estimated over a period prior to the announcement, days !90 to !31, where day 0 is the initial published report. The results are invariant to alternative estimation periods. We focus on the two-day event window for which the excess return is cumulated over days !1 and 0. The adjusted return is the di!erence between the arithmetic return and the conditional expected return, which is the value generated by a leastsquares regression estimated over the pre-event period. The return on the Financial Times market index is used as the explanatory variable, although similar results are obtained using other indexes. Adjusted returns for each "rm are averaged for each day to obtain the average prediction error, and then the daily average prediction errors are cumulated over the event days. The null Table 2 Ownership characteristics of British "rms announcing seasoned equity o!erings, by o!er type, 1986}1994 Ownership concentration and institutional ownership of British "rms listed on the London Stock Exchange that conduct insured rights o!erings and placings over the period 1986 to mid-1994. The results are shown in percentage form, by type of #otation mechanism.

Mean Median

Ownership concentration

Institutional ownership

Insured rights (%)

Placings (%)

Insured rights (%)

Placings (%)

14.7

23.0

28.4

33.9

6.1

16.8

10.7

29.5

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

169

hypothesis of the statistical test is that the excess return equals zero. The test statistic is the ratio of the average prediction error to its standard deviation, calculated over the estimation period. For cross-sectional regressions, the twoday excess returns are the dependent variables.

5. Empirical results In this section we report evidence about the e!ects of announcements of seasoned equity o!erings by British "rms on the London Stock Exchange. Our empirical tests, which use event study methods and regression analysis, provide evidence that is used to draw conclusions about the e!ects of alternative #otation methods on shareholder wealth. 5.1. Share price ewects of seasoned equity owerings by British xrms In Table 3, we report average excess returns for the two-day event window, day !1 and 0, where 0 is the date of the initial announcement of a seasoned equity o!ering. For 220 rights o!erings, the two-day average excess return is !3.09%, statistically signi"cant at the 1% level (t-statistic"!11.90). For this sample of o!erings, 67% of the returns are negative. This result indicates the market expects British managers to conduct rights o!erings when a "rm's equity is overvalued or corporate cash #ows are lower than expected, consistent with information-based models of equity issuance (Myers and Majluf, 1984; Miller and Rock, 1985). For 200 insured rights o!erings, the two-day average excess return is !2.90%, statistically signi"cant at the 1% level (t-statistic"!11.03). For the subsample of insured o!erings, 66% of the returns are negative. These returns are more unfavorable than returns for insured rights o!erings in the U.S., as reported by Eckbo and Masulis (1992), at !1.03%, and Singh (1997), at !1.07%. Bohren et al. (1997) also "nd more favorable returns of !0.23% for this o!ering type in Norway. However, the negative returns for British insured rights o!erings are similar to returns for U.S. "rm commitment o!erings reported by Asquith and Mullins (1986), at !2.7%, Masulis and Korwar (1986), at !3.3%, and Mikkelson and Partch (1986), at !3.6%. Thus, insured rights o!erings, the dominant #otation method in the U.K., are characterized by an adverse selection problem similar to that for "rm commitment o!erings, which are the dominant #otation method in the U.S. For 20 uninsured rights o!erings, the two-day average excess return is !4.96%, statistically signi"cant at the 1% level (t-statistic"!4.39). For the subsample of uninsured o!erings, 85% of the returns are negative. By comparison, Eckbo and Masulis report a two-day excess return of !1.39% (t-statistic"!1.56) for 26 uninsured rights o!erings by U.S. "rms. Thus, a British

170

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

Table 3 Two-day average excess returns for rights o!erings and for placings, 1986}1994
Two-day average excess returns at announcements of seasoned equity issues by British "rms listed on the London Stock Exchange over the period 1986 to mid-1994. Results are shown in percentage form. Relevant samples are disaggregated by type of #otation mechanism, listing venue, subscription take-up, and use of proceeds. The take-up is the proportion of the rights o!ering that is taken up by shareholders. Excess returns are calculated using the market model, in which the parameters are estimated using a least squares regression over a pre-announcement interval !90 to !31. The announcement date is day 0. Sample size

Two-day return (%)

t-statistic

Proportion of negative returns

220 200 20

!3.09 !2.90 !4.96

!11.90 !11.03 !4.39

0.67 0.66 0.85

76

3.31

6.66

0.34

O$cial list Insured rights Placings

174 47

!2.57 1.22

!9.24 1.55

0.67 0.42

USM Insured rights Placings

23 25

!4.20 6.83

!3.79 13.12

0.61 0.20

Panel A: Flotation method Rights o!erings Insured Uninsured Placings Panel B: Listing venue

Panel C: Subscription take-up in insured rights owerings Shareholders Take-up*90% Take-up(90%

111 89

!0.33 !5.91

!1.00 !13.06

0.44 0.81

Blockholders Renounce take-up Other

20 180

!8.59 !2.29

!7.73 !8.27

0.75 0.62

Acquisitions Other

87 113

!1.59 !3.92

!4.56 !10.20

0.61 0.72

Debt reduction Other

97 103

!3.37 !2.49

!7.52 !7.74

0.68 0.66

32 45

4.85 2.27

14.41 2.82

0.25 0.40

103 56

3.29 3.31

4.17 5.68

0.33 0.34

Panel D: Use of proceeds Insured rights

Placings Acquisitions Other Debt reduction Other Signi"cant at the 1% level.
Signi"cant at the 5% level.

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

171

uninsured rights o!ering indicates a signi"cant adverse selection problem, which is not consistent with Eckbo and Masulis's prediction that uninsured rights o!erings are selected by undervalued "rms. The large negative share price reaction to uninsured rights o!erings explains the willingness of British "rms to incur the certi"cation costs of obtaining standby commitments even though the success of the o!ering can be virtually assured by setting a su$ciently low exercise price. On average, standby fees in the U.K. are cost e!ective, taking into account the e!ects of the o!ering on shareholder wealth. Nevertheless, since the sample of uninsured rights o!erings is small, it is di$cult to draw de"nitive conclusions about the di!erential share price e!ects of insured and uninsured rights, and a di!erence in means test generates a calculated t-value of only 1.35. For 76 announcements of placings, the two-day average excess return is 3.31%, statistically signi"cant at the 1% level (t-statistic"6.66). For the sample of placings, 66% of the returns are positive. Compared to a bookbuilt o!ering or a rights o!ering, a placing gives an issuing "rm superior timing #exibility, since this "xed-price bought deal is quickly executed. Despite this greater timing #exibility, placings convey favorable information about "rm value, while British rights o!erings and U.S. "rm commitment o!erings generate signi"cantly negative share price e!ects. Di!erences in returns for U.K. "rms are statistically signi"cant when placings are compared to the results of insured plus uninsured rights o!erings (calculated t-value of 5.71). There are also statistically signi"cant di!erences when placings are compared to uninsured rights o!erings (calculated t-value of 4.56), and to insured rights o!erings (calculated t-value of 5.80). Our results suggest that the placing method of #otation mitigates the adverse selection problem intrinsic to other methods of seasoned equity issuance. Thus, an investment bank's willingness to underwrite a seasoned equity o!ering at an unconditional "xed price, together with the management's decision to avoid a rights o!ering, conveys favorable information and provides e!ective certi"cation of "rm value. The underwriting spread for a placing is a cost-e!ective payment that compensates an underwriter for certifying and monitoring the issuing "rm, distributing the issue, and absorbing the risk of subsequent adverse price changes. The positive share price response implies that placings are underpriced relative to the after market share price. This underpricing allows underwriters to induce outside investors to participate in an equity o!ering through a pricing scheme that is not possible in a rights o!ering. This behavior is consistent with Parsons and Raviv's (1985) model of underpricing of seasoned equity o!erings. Our results are not consistent with Eckbo and Masulis's contention that because certi"cation is an intrinsically noisy phenomenon, underwriters provide only partial certi"cation of "rm quality. Our evidence indicates that alternative #otation methods have di!erential e!ects on shareholder wealth, and that choice of #otation method does not convey a uniform signal in the U.S. and the U.K. Share price responses at seasoned equity o!erings in the U.K. are not consistent with the Heinkel and

172

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

Schwartz (1986) and Eckbo and Masulis (1992) prediction that lower-quality, that is, overvalued, "rms undertake "rm commitment o!erings, while higher-quality, that is, undervalued, "rms use rights o!erings. We suggest that di!erences in share price responses in the U.K. and U.S. markets re#ect cross-country di!erences in the issuance process and the value of underwriter certi"cation. For the U.K. market, the weaker certi"cation of an insured rights o!ering relative to a placing re#ects the fact that, although there is a standby commitment, subscription price is typically at a considerable discount from the pre-announcement share price. As a result, it is unlikely that the rights will become worthless and leave the underwriter holding unsubscribed shares. Thus, the risk to an underwriter in an uninsured rights o!ering is modest, so less certi"cation value is provided in a rights o!ering, especially compared to a placing in which the underwriter commits upfront to purchase the entire o!ering at a "xed price. We disaggregate the samples of insured rights o!erings and placings based on trading venue, shareholder and blockholder take-up, use of proceeds, and ownership characteristics. With regard to trading venue, most of the sample "rms are on the O$cial List. A subset of sample "rms, which are generally younger and have smaller capitalization values, trades on the Unlisted Securities Market (USM). The USM was renamed the Alternative Investment Market (AIM) in 1995. Both the USM and AIM are component entities of the London Stock Exchange. For insured rights o!erings, average excess returns are !2.57% (t-statistic"!9.24) for O$cial List "rms and !4.20% (t-statistic"!3.79) for USM "rms, and a di!erence in means test is not statistically signi"cant (calculated t-value of 0.55). For placings, the returns are 1.22% (t-statistic"1.55) for O$cial List "rms, and 6.83% (t-statistic"13.12) for USM "rms, and a di!erence in means test generates a calculated t-value of 1.65. These results provide modest evidence that smaller "rms are characterized by more severe informational asymmetries than larger "rms. Di!erence in means tests between the two types of #otation methods generate signi"cant calculated t-values of 2.31 for O$cial List "rms and 2.61 for USM "rms. Kang and Stulz (1996) document a signi"cantly negative market reaction to equity issuance in Japan by large "rms, but a positive market reaction for small "rms. They attribute this di!erence in returns to the dominant role that Japanese banks play in the timing of securities issuance at small "rms, implying less of an adverse selection problem. Since the pattern of returns for placings compared to rights o!erings for USM "rms is similar to that for O$cial List "rms, we conclude that the Kang and Stulz hypothesis does not explain the positive returns for British placings. Eckbo and Masulis (1992) contend that managerial expectations about shareholder take-up is a key factor in#uencing choice of #otation method. They predict that the lower the proportion of shares expected to be taken up, the more severe the adverse selection problem, leading managers to be less likely to adopt

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

173

the rights method of #otation. They "nd that take-up rates for insured rights in the U.S. are close to 100%, and excess returns for insured rights o!erings are less unfavorable than for "rm commitment o!erings. Singh (1997) "nds modest evidence for the role of take-up in a sample of rights o!erings by U.S. utilities. We "nd that the excess return for insured rights, when take-up equals or exceeds 90%, is !0.33% (t-statistic"!1.00). For this subsample of well-subscribed insured rights o!erings, 44% of the returns are negative. For insured rights with take-up less than 90%, the excess return is !5.91% (t-statistic"!13.06), and 81% of the returns are negative. A di!erence in means test is signi"cant at the 1% level (calculated t-value of 4.81), indicating that share price response and take-up vary directly for British "rms, which is consistent with the Eckbo and Masulis hypothesis. Nevertheless, even for insured rights o!erings with high take-up, the average excess return is not positive, as it is for placings. Thus, a standby commitment, coupled with high expected shareholder take-up, is not a perfect substitute for the underwriter certi"cation entailed in a placing. In the U.K., then, there is an adverse selection problem for the typical insured rights o!ering relative to a placing. Announcements of rights o!erings in the U.K. sometimes indicate that a blockholder will not take up its share allocation. Demsetz (1986) and Shleifer and Vishny (1986) contend that blockholders e!ectively monitor corporate activity and alleviate agency di$culties. From this perspective, blockholder renunciation is a deleterious signal of "rm value. Alternatively, Fama and Jensen (1983) and DeAngelo and DeAngelo (1985) contend that reduced ownership concentration enhances "rm value by strengthening the market for corporate control, which deters entrenchment. Morck et al. (1988) and McConnell and Servaes (1990) "nd that moderately high ownership concentration has a signi"cantly negative impact on "rm value, and Slovin and Sushka (1993) report that deaths of inside blockholders reduce ownership concentration and increase "rm value, evidence consistent with the entrenchment hypothesis. Kothare (1997) argues that a non-rights equity o!ering induces a more di!use ownership structure which signi"cantly decreases the bid}ask spread. From this perspective, blockholder renunciation reduces ownership concentration, and should enhance "rm value. For the 20 insured rights o!erings in which there is blockholder renunciation, the two-day excess return is !8.59% (t-statistic"!7.73), while the remaining 180 events have a return of !2.29% (t-statistic"!8.27). A di!erence in means test is signi"cant at the 5% level (calculated t-value of 2.03), indicating that blockholder renunciation is a negative signal of "rm value. Mikkelson and Partch (1986) and Masulis and Korwar (1986) report that use of proceeds has little e!ect on share price response for U.S. "rm commitment o!erings, but there is no comparable analysis available for rights o!erings. Excess returns for insured rights o!erings in the U.K. are !1.59% (t-statistic"!4.56) when proceeds are used for acquisitions, and !3.92%

174

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

(t-statistic"!10.20%) when proceeds are not used for acquisitions. A di!erence in means test is signi"cant at the 5% level (calculated t-value of 2.06). For placings, the excess returns are 4.85% (t-statistic"14.41) when use of proceeds indicates acquisitions, and 2.27% (t-statistic"2.82) when acquisitions are not indicated. A di!erence in means test has a calculated t-value of 1.57. For insured rights o!erings, the returns are !3.37% (t-statistic"!7.52) when proceeds are used to reduce debt, and !2.49% (t-statistic"!7.74) when debt reduction is not indicated. For placings, the returns are 3.29% (t-statistic"4.17) for "rms that repay debt, and 3.31% (t-statistic"5.68) otherwise. Neither di!erence in means test is statistically signi"cant. We conclude that use of proceeds has a limited impact on share price reaction to equity issuance in the U.K., consistent with "ndings in the U.S. Rights o!erings typically have little e!ect on ownership structure, while placings entail the sale of shares to institutions and other outside investors, resulting in lower ownership concentration. As reported in Table 4, share price e!ects at insured rights o!erings are !2.90% (t-statistic"!5.18) when ownership concentration equals or is greater than 5%, and !3.68% (t-statistic"!9.77) when ownership concentration is less than 5%. The calculated t-value for the di!erence in means is 1.69, signi"cant at the 10% level. The comparable returns for placings are 4.44% (t-statistic"5.90) when concentration equals or is greater than 5%, and 1.71% (t-statistic"3.48) when concentration is less than 5%. This di!erence in means has a calculated t-value of 1.63. Thus, there is modest evidence of a more favorable share price e!ect for rights o!erings and placings by "rms with concentrated ownership structures. Since there is evidence that ownership concentration has a nonlinear e!ect on "rm value (Morck et al., 1988; McConnell and Servaes, 1990), we disaggregate the sample into several ranges of concentration. In general, for insured rights o!erings, there is a less adverse share price response for "rms with more concentrated ownership. This relation holds up to the 40% range. For placings, excess returns are also more favorable for "rms with concentrated ownership structures. Pound (1988) argues that institutional investors can enhance "rm value by providing e!ective monitoring at lower cost than atomistic shareholders. However, he also suggests that institutional investors may align with managerial interests, harming shareholder value. Since placings increase institutional ownership while a rights o!ering typically leaves ownership structure unchanged, we disaggregate the sample by institutional ownership. In general, excess returns for insured rights o!erings vary little with respect to institutional ownership. However, there are more favorable returns for placings o!ered by "rms with institutional holdings between 20% and 40%, versus "rms with institutional ownership below 20% or above 40%. Di!erence in means tests for placings for these ownership ranges generate calculated t-values of 2.03 and 1.67, signi"cant at the 5% and 10% levels, respectively.

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

175

Table 4 Two-day average excess returns for insured rights o!erings and for placings, based on ownership concentration and institutional ownership, 1986}1994 Two-day average excess returns at announcements of insured rights o!erings and placings by British "rms listed on the London Stock Exchange over the period 1986 to mid-1994. Results are shown in percentage form. Relevant samples are disaggregated on the basis of ownership concentration and institutional ownership. Excess returns are calculated using the market model, in which the parameters are estimated using a least-squares regression over a pre-event interval !90 to !31. The announcement date is day 0. The t-statistics are in parentheses, the percent of negative returns is in brackets, and N is the sample size. Two-day excess returns

Ownership concentration

Institutional ownership

Insured rights

Placings

Insured rights

Placings

!3.68% (!9.77) [0.61] N"90

1.71% (3.48) [0.42] N"20

!2.84% (!3.55) [0.71] N"13

2.06% (3.28) [0.38] N"4

!2.90% (!5.18) [0.68] N"104

4.44% (5.90) [0.29] N"44

!2.89% (!10.43) [0.60] N"118

3.66% (6.30) [0.30] N"60

!1.74% (!3.28) [0.61] N"59

1.19% (1.43) [0.31] N"13

!2.45% (!5.33) [0.64] N"65

0.88% (2.14)
[0.47] N"17

20%)C(40%

!0.86% (!1.25) [0.65] N"28

7.78% (9.48) [0.17] N"18

!3.65% (!8.04) [0.72] N"80

6.25% (10.14) [0.30] N"23

40%)C

!4.86% (!4.73) [0.62] N"17

3.17% (1.79) [0.43] N"13

!2.42% (!5.02) [0.64] N"40

2.27% (4.49) [0.21] N"23

OwnershipI5% C(5%

C*5%

Concentration by ranges 5%)C(20%

Signi"cant at the 1% level.
Signi"cant at the 5% level.

5.2. Cross-sectional regression results For cross-sectional regression analysis, the dependent variables are the twoday excess returns at announcements of insured rights o!erings and placings. Since independent variables re#ect issuing "rm and o!ering characteristics, regression analysis generates estimates of the e!ects of these characteristics on

176

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

announcement returns, ceteris paribus. Several continuous variables are speci"ed to test hypotheses that are not amenable to event study analysis. For insured rights regressions, independent variables include four qualitative variables: blockholder renunciation, denoted DRN; use of proceeds for acquisitions, ACQS; use of proceeds for debt reduction, DEBT; and trading venue for "rms on the O$cial List, OFFLIST. There are "ve continuous variables. The "rst, denoted TAKEUP, is the proportion of the o!ering taken up by shareholders. The second, size of the o!ering, or GPMV, is calculated as gross proceeds divided by "rm market value. The third is "rm size, or LOGMV, calculated as the logarithm of "rm market value. The fourth, denoted INST, is the proportion of shares held by institutions. The "fth is ownership concentration, or OCON, speci"ed in quadratic form. The speci"cations also include a variable for the subscription price discount, DISC. In the U.K., exercise price is reported in the initial announcement, a practice that permits a more e!ective test of the valuation e!ects of the subscription price discount on the share price response in an insured rights o!ering than is available in the U.S., where only the o!er day discount can be tested. An anomaly about rights o!erings is the reluctance of managers to issue uninsured rights with a su$ciently deep discount to e!ectively assure the exercise of the rights. By avoiding uninsured o!erings, managers in both countries incur the expense of standby commitments. Eckbo and Masulis (1992) "nd that the o!er day subscription discount has no e!ect on excess returns in the U.S. Bohren et al. (1997) report similar results for Norwegian rights o!erings, and Singh (1997) "nds a weakly negative relationship for rights o!erings by U.S. utilities. As reported in Table 5, the subscription price discount has a consistently negative coe$cient that is signi"cant at the 1% level. This result implies that the discount is a negative signal of "rm value, and suggests why managers are reluctant to conduct rights o!erings with a low exercise price. Although a large discount assures the success of a rights o!ering, the market infers that managers expect the share price to fall over the subscription period, and therefore revises expectations about "rm performance downward. Thus, high-quality British "rms that conduct insured rights o!erings signal their quality by setting a high exercise price, that is, a low discount. This result is consistent with the substantial negative returns at announcements of uninsured rights o!erings, which have large discounts to assure the success of the o!ering. The regression coe$cients for shareholder take-up are positive and signi"cant at the 1% level. These results indicate that high shareholder take-up mitigates the negative share price response to an insured rights o!ering. Further, these results are consistent with Eckbo and Masulis's contention that high expected take-up reduces the adverse selection problem associated with equity issuance. The qualitative variable indicating blockholder renunciation is signi"cantly negative, consistent with the event study evidence. Ownership concentration, institutional holdings, use of proceeds, o!er size, "rm size, and trading venue do not a!ect excess returns at insured rights

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

177

o!erings. Moreover, the size and statistical signi"cance of the coe$cients for the subscription price discount, shareholder take-up, and blockholder renunciation are not a!ected by the inclusion of variables that re#ect other o!ering and "rm characteristics. The relevant regression equations typically have R statistics in excess of 0.35, which indicates that a small set of characteristics of the equity issuance process explains a considerable proportion of the variation in share price response at insured rights o!erings by British "rms. In Table 6, the regressions exclude variables for the subscription price discount, shareholder take-up, and blockholder renunciation, since these characteristics are not relevant for placings. Instead, we specify a variable unique to placings to capture underwriter compensation. The variable SPREAD re#ects the di!erence between the price the underwriter pays the issuing "rm and the share price on the day prior to the placing announcement. Giammarino and Lewis (1988) argue that the spread re#ects an issuing "rm's eagerness to raise funds to exploit productive opportunities. Therefore, a larger spread should be a more favorable signal of "rm value. The results, shown in Table 6, indicate that the underwriting spread has a negative coe$cient that is signi"cant at the 1% level, contrary to Giammarino and Lewis's prediction. The coe$cients of the linear and quadratic terms for ownership concentration are statistically signi"cant, and imply that "rms with greater ownership concentration sustain a more positive share price response to placings. This relation holds until ownership concentration reaches 40% of "rm shares. For "rms with ownership concentration greater than 40%, the coe$cients indicate that the marginal e!ect of increased concentration is negative. This evidence is consistent with the event study results, and suggests that placings by "rms with concentrated ownership enhance value by increasing ownership dispersion, thereby increasing "rm exposure to external monitoring and reducing the potential for managerial entrenchment. The coe$cients of o!ering size are signi"cantly positive. Miller and Rock (1985) contend that a larger o!ering indicates a greater shortfall of cash #ow relative to expectations and a greater need for external "nancing, implying a more unfavorable share price e!ect. However, our results indicate that placings are well-certi"ed transactions and that the larger the o!ering relative to "rm size, the more positive the e!ect. Thus, an underwriter's willingness to take on the greater risk of a larger placing generates a more favorable share price e!ect. A larger issue size also induces a greater reduction in ownership concentration, implying an increased potential for value-enhancing external monitoring. With regard to use of proceeds, the coe$cients for the acquisitions variable are positive and statistically signi"cant, while the coe$cient for the debt reduction variable is not statistically signi"cant. None of the remaining variables that re#ect other characteristics of the o!ering or the issuing "rm, including institutional ownership, "rm size, and trading venue, are signi"cant, and their

DRN

TAKEUP

DISC

!0.0044 (!7.98)

(1)

(2)

0.0009 (3.03) !0.0646 (!3.15)

(3)

Alternate regression speci"cations (4)

(5)

!0.0600 (!3.50)

0.0008 (2.81)

!0.0042 (!7.90)

(6)

!0.0537 (!3.07)

0.0009 (3.14)

!0.0042 (!7.79)

(7)

!0.0541 (!3.07)

0.0009 (3.17)

!0.0042 (!7.87)

(8)

!0.0581 (!3.16)

0.0011 (3.47)

!0.0043 (!7.79)

(9)

Cross-sectional regressions estimated to explain the two-day cumulative excess returns from event studies for the 200 announcements of insured rights o!erings by British "rms over the period 1986 to mid-1994. The data are taken from the Extel International Financial Data Base, the Moody's (International) Manuals, the Yearbook of the London Stock Exchange, the Financial Times, the Times (London), and the Dow Jones News Retrieval Service. The speci"cation estimated is CR"b #b RX #;, where the dependent variable, CR, is de"ned as the two-day (!1, 0) cumulative excess  G G returns from the event study for the sample of insured rights o!erings, and the X are de"ned as: (1) DISC"(P !P )/P where P is the exercise G \  \ C price and P is the closing share price the day before the initial announcement; (2) TAKEUP is the proportion of the o!ering taken up by shareholders \ of the "rm; (3) DRN is a qualitative variable that equals one when the announcement reports that a blockholder will not take up its share allocation, and equals zero otherwise; (4) OCON is the ratio of shares held by the control group relative to total shares outstanding, and (OCON) is the square of OCON; (5) LOGMV is the logarithm of the market value of the announcing "rm; (6) GPMV is the ratio of gross proceeds to the market value of the announcing "rm; (7) ACQS is a qualitative variable that equals one when the intended use of proceeds is for acquisitions, and equals zero otherwise; (8) DEBT is a qualitative variable that equals one when the intended use of proceeds is for debt reduction, and equals zero otherwise; (9) OFFLIST is a qualitative variable that equals one when the issuing "rm is traded on the O$cial List of the London Stock Exchange, and equals zero when it is traded on the Unlisted Securities Market (USM); and (10) INST is the size of shareholdings by institutions relative to total shares outstanding.

Table 5 Cross-sectional regressions for excess returns for insured rights o!erings, 1986}1994

178 M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

!0.1125 (!3.96)

!0.0213 (!3.07)

!0.0330 (!3.40)

!0.0149 (!0.57)

!0.0302 (!1.12)

0.2703 63.73

0.0508 9.20

0.0546 9.94

Signi"cant at the 1% level.
Signi"cant at the 5% level. t-statistics are in parentheses.

R F 0.0048 0.42

0.0023 0.42

0.3465 30.04

0.3577 16.88

0.3341 14.23

0.3528 7.81

!0.0379 (!0.86)

!0.0224 (!0.74)

Constant !0.0370 (!2.11)


!0.0006 (!1.70)

0.0197 (0.93)

INST

OFFLIST

!0.0023 (!0.20)

DEBT

!0.0050 (!0.44)

!0.0000 (!0.52)

0.0010 (0.97)

!0.0025 (!0.18)

!0.0032 (!0.35)

!0.0000 (!0.47)

0.0009 (0.96)

ACQS

0.0054 (0.65)

!0.0000 (!0.57)

0.0011 (1.21)

0.0023 (1.52)

!0.0472 (!4.25)

!0.0000 (!0.91)

0.0009 (0.86)

GPMV

LOGMV

(OCON)

OCON

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190 179

(OCON)

OCON

SPREAD

!0.0021 (!3.50)

(1)

0.0031 (2.40)


!0.0000 (!2.10)


(2)

(3)

Alternate regression speci"cations (4)

!0.0000 (!2.15)


0.0028 (2.47)


!0.0024 (!4.34)

(5)

!0.0000 (!2.12)


0.0028 (2.30)


!0.0024 (!4.05)

(6)

!0.0000 (!2.08)


0.0028 (2.33)


!0.0024 (!4.14)

(7)

!0.0000 (!2.08)


0.0029 (2.70)

!0.0022 (!4.25)

(8)

!0.0000 (!2.17)


0.0028 (2.51)


!0.0022 (!3.92)

(9)

Cross-sectional regressions estimated to explain the two-day cumulative excess returns for announcements of 76 placings by British "rms over the period 1986 to mid-1994. The data are taken from the Extel International Financial Data Base, the Moody's (International) Manuals, the Yearbook of the London Stock Exchange, the Financial Times, the Times (London), and the Dow Jones News Retrieval Service. The speci"cation estimated is CR"b #b RX #;, where the dependent variable, CR, is de"ned as the two-day (!1, 0) cumulative excess returns from the event study for the  G G sample of placings and the X are de"ned as: (1) SPREAD is the di!erence between the closing share price on the day prior to announcement and the price G received by the issuing "rm as a ratio to the closing share price on the day prior to announcement; (2) OCON is the ratio of shareholdings by the control group relative to total shares outstanding, and (OCON) is the square of OCON; (3) GPMV is the ratio of gross proceeds to the market value of the announcing "rm; (4) LOGMV is the logarithm of the market value of the announcing "rm; (5) ACQS is a qualitative variable that equals one when the intended use of proceeds are for acquisitions, and equals zero otherwise; (6) DEBT is a qualitative variable that equals one when the intended use of proceeds are for debt reduction, and equals zero otherwise; (7) OFFLIST is a qualitative variable that equals one when the issuing "rm is traded on the O$cial List of the London Stock Exchange, and equals zero when it is traded on the Unlisted Securities Market (USM); and (8) INST is the size of shareholdings by institutions relative to total shares outstanding.

Table 6 Cross-sectional regressions for excess returns for placings, 1986}1994

180 M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

0.0520 3.83

Signi"cant at the 1% level.
Signi"cant at the 5% level. t-statistics are in parentheses.

0.0812 3.05


0.0071 0.50

0.3091 7.48

0.2621 5.95

0.3091 5.90

0.4058 9.00

0.4303 5.20

0.1490 12.25

R F

!0.0173 (!1.24)

!0.0017 (!0.05)

0.0132 (0.46)

0.0163 (0.94)

0.0495 (3.10)

0.0410 (4.52)

0.0465 (1.89)

0.0508 (3.28)

0.0008 (0.12)

0.0002 (2.58)


Constant

0.0097 (0.81)

!0.0008 (!0.14)

0.0002 (3.05)

!0.0003 (!0.94) 0.0410 (2.16)


!0.0070 (!1.32)

0.0002 (2.12)


INST 0.0179 (1.69)

!0.0037 (!0.71)

0.0002 (2.53)


!0.0150 (!0.87)

0.0075 (0.59)

0.0002 (1.96)

OFFLIST

DEBT

ACQS

LOGMV

GPMV

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190 181

182

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

inclusion in the speci"cation does not a!ect the size or statistical signi"cance of the coe$cients for underwriting spread, o!ering size, ownership concentration, and use of proceeds. The R statistics for the relevant regressions are typically in excess of 0.40, which indicates that a small set of factors explains a considerable proportion of the variation in the share price response to announcements of placings in the U.K. We also test whether the conditional mean value of the share price response to a British seasoned equity o!ering di!ers systematically across the two #otation mechanisms by estimating a cross-sectional regression that pools the placings and insured rights samples, and includes a qualitative variable that equals one for placings, and zero for rights o!erings. This qualitative variable, not reported in the table, has a positive coe$cient that is statistically signi"cant at the 1% level, indicating that share price reaction to a placing is more favorable than to an insured rights o!ering, ceteris paribus. We generate out-of-sample forecasts of excess returns and compare them to actual returns. Using insured rights regression coe$cients, we obtain forecast values of the excess returns that placings "rms would have sustained had they conducted rights o!erings instead. The results indicate that 92% of the "rms in the placings sample would have sustained more unfavorable returns if they had issued insured rights o!erings. The median di!erence between forecast and actual returns is !4.19%, and is statistically signi"cant using the Wilcoxon signed ranks test (p"0.00). Applying the same procedure, we "nd that 62% of the "rms in the insured rights sample would have sustained more favorable returns if they had issued placings. The median di!erence between forecast and actual returns is 2.03%, and is statistically signi"cant using the Wilcoxon signed ranks test (p"0.00). These results are consistent with the event study evidence of a more favorable share price reaction to placings relative to insured rights o!erings. 5.3. Results for insured rights owerings prior to 1986 Prior to 1986, London Stock Exchange policy e!ectively mandated preemption, leaving British companies to raise seasoned equity through rights o!erings. These institutional arrangements re#ected the importance of shareholder pre-emptive rights and the view that a rights o!ering is an e!ective, low-cost mechanism for raising seasoned equity. Our results for 1986 to mid1994 suggest that regulatory changes that permitted placings facilitated selfselection by high-quality "rms. We generate a sample of insured rights o!erings from 1982 to 1985, a period prior to the policy change, and examine the valuation e!ects of these o!erings to assess the impact of this change in "nancing #exibility. Using the Financial Times index, which contained a speci"c category for rights o!erings until 1987, we "nd 183 insured rights o!erings with an identi"able, initial public announcement by British "rms with su$cient daily share prices on the Datastream database to conduct an event study analysis. We

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

183

exclude secondary issues and joint issues from the sample. There are 33 events that occur in 1982, 71 events in 1983, 48 events in 1984, and 31 events in 1985. For this sample, the mean discount is 21.6% and the median discount is 19.2%, the mean shareholder take-up is 87.9% and the median take-up is 93.7%, and mean ownership concentration is 14.0%. These "gures are similar to the data for the 1986}1994 sample. We are unable to obtain data for fees or institutional ownership. In Table 7, for 183 insured rights o!erings, the two-day average excess return is !1.88%, which is statistically signi"cant at the 1% level (t-statistic "!7.48). For these o!erings, 67% of returns are negative. This result indicates that, for the pre-deregulation period, the average excess return to insured rights o!erings is negative, but less adverse than the !2.90% return for the postderegulation period. The di!erence in means between the two returns is statistically signi"cant at the 10% level (calculated t-value of 1.67). This evidence is

Table 7 Two-day average excess returns for insured rights o!erings, based on o!ering and "rm characteristics, 1982}1985 Two-day excess returns (in percent) at announcements of insured rights o!erings of seasoned equity by British "rms listed on the London Stock Exchange over the period 1982}1985. The data are obtained from Datastream, the Moody's (International) Manuals, the Yearbook of the London Stock Exchange, the Financial Times, and the Times (London). Results are shown in percentage form. Relevant samples are disaggregated by subscription take-up and use of proceeds. Excess returns are calculated using the market model in which the parameters are estimated using a least squares regression over a pre-announcement interval !90 to !31. The announcement date is day 0.

Full sample

Sample size

Two-day return (%)

t-statistic

Proportion of returns negative

183

!1.88

!7.48

0.67

95 45

!1.42 !2.20

!4.89 !4.49

0.65 0.67

24 159

!1.99 !1.86

!4.34 !5.66

0.67 0.67

64 119

!1.50 !2.09

!4.37 !5.09

0.67 0.67

52 131

!2.16 !1.77

!3.43 !6.16

0.69 0.66

Subscription take-up Shareholders Take-up*90% Take-up(90% Blockholders Renounce take-up Other Use of proceeds Acquisitions Other Debt reduction Other

Signi"cant at the 1% level.

184

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

consistent with the hypothesis that the increase in corporate "nancing #exibility entailed in the option to conduct placings worsened the adverse announcement e!ect for insured rights o!erings after 1985. With more "nancing options available, high-quality "rms capable of meeting the certi"cation standards for placings were able to distinguish themselves from "rms conducting rights o!erings. We disaggregate the sample by shareholder take-up and we "nd that the two-day excess returns are !1.42% (t-statistic"!4.89) when take-up is 90% or more, and !2.20% (t-statistic"!4.49) when take-up is below 90%. This di!erence in returns is not statistically signi"cant (calculated t-value of 0.62), in contrast to the signi"cant impact of take-up in the 1986 to 1994 sample. Thus, the share price reaction to a rights o!ering with low take-up becomes more adverse once high-quality "rms have the option to use a placing rather than a rights o!ering. Blockholder renunciation was one of the few feasible mechanisms for increasing ownership dispersion prior to 1986. For the 24 events in which a blockholder renounces the take-up of shares, the two-day excess return is !1.99% (t-statistic"!4.34), compared to !1.86% (t-statistic"!5.66) for the remaining events, a di!erence that is small and not statistically signi"cant. We conclude that prior to 1986, blockholder renunciation and shareholder take-up did not a!ect the share price response to a rights o!ering announcement, contrary to the signi"cant e!ect after 1985, a period when high-quality "rms seeking to increase ownership dispersion could utilize a placing. In Table 8, we report results according to various ranges of ownership concentration, and "nd little e!ect on the reaction to an insured rights o!ering. None of the di!erences between these sets of returns is statistically signi"cant. The pattern of our results suggests that after the London Stock Exchange allowed British "rms the option to undertake a placing rather than a rights o!ering, high-quality "rms gained the opportunity to self-select and signal their quality by utilizing the placing method of #otation. High-quality "rms with concentrated ownership structures could utilize placings both to raise external equity and to create greater ownership dispersion. This "nding explains why a "rm conducting an insured rights o!ering after 1985 in which a blockholder renounces its share allocation sustains a negative share price response, even though renunciation is expected to enhance ownership dispersion. Overall, these results suggest a separating equilibrium after deregulation in 1986. Prior to 1986, however, a high-quality "rm seeking to raise external equity and to induce greater ownership dispersion was restricted to using a rights o!ering with low shareholder take-up. This constraint on corporate "nancing decisions implies a pooling equilibrium prior to 1986, as evidenced by the pattern of share price responses. We estimate cross-sectional regressions that explain two-day excess returns for insured rights o!erings for the pre-1986 period as a function of variables speci"ed in the regressions for the 1986}1994 insured rights sample. The results, reported in Table 9, indicate there is little relationship between the share price

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

185

Table 8 Two-day average excess returns for insured rights o!erings, based on ownership concentration, 1982}1985 Two-day average excess returns at announcements of insured rights o!erings by British "rms listed on the London Stock Exchange over the period 1982}1985. Results are shown in percentage form. Relevant samples are disaggregated on the basis of ownership concentration. Excess returns are calculated using the market model in which the parameters are estimated using a least squares regression over a pre-event interval !90 to !31. The announcement date is day 0.

OwnershipJ5% C(5% C*5%

Sample size

Two-day return (%)

t-statistic

Proportion of returns negative

109 74

!2.45 !1.05

!6.47 !2.26


0.69 0.65

23 24 27

!0.55 !2.41 !0.26

!0.55 !3.17 !0.34

0.57 0.75 0.63

Concentration by ranges 5%)C(20% 20%)C(40% 40%)C Signi"cant at the 1% level.
Signi"cant at the 5% level.

response to pre-1986 insured rights o!erings and subscription price discount, shareholder take-up, or blockholder renunciation, variables that are signi"cant in the 1986}1994 period. None of the other variables tested in the regressions generate signi"cant results. The lack of statistical signi"cance for variables in the pre-1986 period suggests that the change in Stock Exchange policy to allow placings altered the framework of the equity issuance process and shifted the market for seasoned equity issuance from a pooling equilibrium to a separating equilibrium. Consistent with this conclusion, calculated F-statistics for Chow tests reject the null hypothesis of equality of regression coe$cients between the two sample periods for each regression speci"cation. Using the regressions estimated for the pre- and post-deregulation periods, we generate out-of-sample predictions for insured rights o!erings. The forecasts indicate that 61% of the "rms in the pre-1986 insured rights sample would have sustained more unfavorable excess returns if they had issued insured rights after 1985. The median di!erence between forecast and actual returns is !1.30%, an amount that is statistically signi"cant using the Wilcoxon signed ranks test (p"0.02). Out-of-sample forecasts also indicate that 65% of the "rms in the post-1985 insured rights sample would have sustained more favorable excess returns if they had issued insured rights before 1986. The median di!erence between forecast and actual returns is 2.01%, an amount that is statistically signi"cant using the Wilcoxon signed ranks test (p"0.00). In comparison, 86% of the "rms in the post-1985 placings sample would have sustained more

186

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

Table 9 Cross-sectional regressions for excess returns for insured rights o!erings, 1982}1985 Cross-sectional regressions estimated to explain the two-day cumulative excess returns from event studies for 183 announcements of insured rights o!erings by British "rms over the period 1982}1985. The data are obtained from Datastream, the Moody's (International) Manuals, the Yearbook of the London Stock Exchange, the Financial Times, and the Times (London). The speci"cation estimated is CR"b #b RX #;, where the dependent variable, CR, is de"ned as the two-day (!1, 0)  G G cumulative excess returns from the event study for the sample of insured rights o!erings, and the X are de"ned as: (1) DISC"(P !P )/P where P is the exercise price and P is the closing G \  \  \ share price the day before the announcement; (2) TAKEUP is the proportion of the o!ering taken up by shareholders of the "rm; (3) DRN is a qualitative variable that equals one when the announcement reports that a blockholder will not take up its share allocation, and equals zero otherwise; (4) OCON is the ratio of shares held by the control group relative to total shares outstanding, and (OCON) is the square of OCON; (5) LOGMV is the logarithm of the market value of the announcing "rm; (6) GPMV is the ratio of gross proceeds to the market value of the announcing "rm; (7) ACQS is a qualitative variable that equals one when the intended use of proceeds is for acquisitions, and equals zero otherwise; (8) DEBT is a qualitative variable that equals one when the intended use of proceeds is for debt reduction, and equals zero otherwise; (9) OFFLIST is a qualitative variable that equals one when the issuing "rm is traded on the O$cial List of the London Stock Exchange, and equals zero when it is traded on the Unlisted Securities Market (USM). Alternate regression speci"cations (1) DISC TAKEUP DRN OCON (OCON) LOGMV GPMV

(2)

(3)

(4)

(5)

!0.0001 (!0.08)

(6)

(7)

!0.0007 !0.0007 (!1.15) (!1.01) 0.0006 (1.65)

0.0005 (1.24)

0.0005 (1.25)

0.0005 !0.0052 (0.03) (!0.22)

!0.0012 (!0.08) !0.0004 (!0.58)

!0.0004 (!0.51)

0.0000 (1.26)

0.0000 (0.93) !0.0021 (!0.31)

!0.0067 (!0.74) !0.0000 (!0.32)

ACQS

0.0009 (0.07)

DEBT

0.0034 (0.23)

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

187

Table 9 (continued) Alternate regression speci"cations (1)

(2)

(3)

(4)

(5)

(6)

(7)

OFFLIST Constant R F

0.0145 (0.62) !0.0194 !0.0740 !0.0187 !0.0219 !0.0160 !0.0468 !0.0550 (!1.54) (!2.28) (!3.12)
(!3.15)
(!1.47) (!1.20) (!1.06) 0.0001 0.01

0.0196 2.76

0.0000 0.01

0.0243 2.23

0.0005 0.10

0.0262 1.20

0.0424 0.56

Signi"cant at the 5% level.
Signi"cant at the 1% level. t-statistics are in parentheses.

unfavorable excess returns if they had issued insured rights before 1986. The median di!erence between forecast and actual returns is !3.99%, an amount that is statistically signi"cant using the Wilcoxon signed ranks test (p"0.00).

6. Conclusions We analyze valuation e!ects of seasoned equity issuance announcements by British "rms on the London Stock Exchange and assess how choice of #otation method a!ects shareholder wealth, given the enhanced #exibility about #otation method that British "rms gained in 1986. British "rms conduct a majority of seasoned equity issuance in the form of rights o!erings, which are typically insured. A considerable proportion of equity issuance since 1986 consists of placings, which are o!erings in which an underwriter purchases the issuing "rm's shares on the spot at a "xed price. The underwriter sells the shares to its clients, who are primarily institutions and other outside investors. Contrary to U.S. underwriting practices, all terms of a seasoned equity o!ering in the U.K. are reported in the initial announcement. Consequently, underwriters are required to price the o!ering without knowing the market reaction to the o!ering announcement, unlike bookbuilding practices in the U.S. where investment banks set the "nal o!er price and size just before the issuance date. In addition, placings o!er a mechanism for increasing ownership dispersion to "rms with concentrated ownership. Thus, placings attract increased external monitoring and greater exposure to the market for corporate control. It is well-documented that announcements of seasoned equity o!erings depress a "rm's share price, an e!ect ascribed to the adverse selection problem that arises when managers are better informed than outside investors. Results

188

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

derived from U.S. data suggest that this adverse selection problem is greater for "rm commitment seasoned equity o!erings than for rights o!erings. Heinkel and Schwartz (1986) and Eckbo and Masulis (1986) predict that managers of "rms utilizing rights o!erings have more favorable private information than "rms that choose "rm commitment o!erings. Our study of seasoned equity issuance in the U.K. provides evidence that "rms utilizing insured rights o!erings sustain more adverse valuation e!ects than "rms that conduct placings. Placings, which entail valuable underwriting services and enhance ownership dispersion, generate a signi"cant increase in issuing "rm share price. Insured rights o!erings generate a signi"cant decline in share price similar to that induced by "rm commitment o!erings in the U.S. Announcements of British insured rights o!erings that are characterized by high shareholder take-up do not a!ect "rm value, while rights o!erings that elicit lower shareholder take-up have signi"cantly negative announcement e!ects. Thus, our evidence indicates that high shareholder take-up mitigates adverse selection problems of rights o!erings. The subscription price discount in a rights o!ering is a negative signal of value, so although a deep discount in e!ect guarantees success of the o!ering, it has an adverse e!ect on "rm value. Furthermore, uninsured rights o!erings, which are issued at a substantial discount from pre-announcement share price, have large deleterious e!ects on shareholder wealth. Our evidence suggests that underwriter certi"cation in the U.K. is a key "nancial phenomenon that is important in preserving shareholder value when a "rm taps the seasoned equity market. In a placing, an underwriter buys the o!ering on the spot at a "xed price, provides an issuing "rm with certainty of proceeds, and takes on the risk of subsequent adverse share price movements. Despite the direct costs a "rm incurs in obtaining the backing of an underwriter for a placing, when market valuation e!ects are taken into account, placings are cost e!ective. We "nd that the share price response to an insured rights o!ering is more adverse after British "rms gained the #exibility to conduct placings in 1986. Thus, the introduction of placings facilitated self-selection of "rms seeking external equity "nancing, and exacerbated the adverse selection problem associated with insured rights o!erings. Moreover, prior to 1986, shareholder take-up and blockholder renunciation had no e!ect on share price responses to announcements of insured rights o!erings. Overall, our evidence suggests that the option for British "rms to conduct placings instead of rights o!erings altered the "nancial environment and shifted the market for seasoned equity issuance from a pooling equilibrium to a separating equilibrium.

References Asquith, P., Mullins, D., 1986. Equity issues and o!ering dilution. Journal of Financial Economics 15, 61}89.

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

189

Bohren, O., Eckbo, B., Michalsen, D., 1997. Why underwrite rights o!erings? some new evidence. Journal of Financial Economics 46, 223}261. Brealey, R., Myers, S., 1984. Principles of Corporate Finance. McGraw-Hill, New York, NY. Brennan, M., Franks, J., 1997. Underpricing, ownership, and control in initial public o!erings of equity securities in the U.K. Journal of Financial Economics 45, 391}414. DeAngelo, H., DeAngelo, L., 1985. Managerial control of voting rights: a study of public corporations with dual classes of common stock. Journal of Financial Economics 14, 33}71. Demsetz, H., 1986. Corporate control, insider trading, and rates of return. American Economic Review 76, 313}316. Eckbo, B., Masulis, R., 1992. Adverse selection and the rights o!er paradox. Journal of Financial Economics 32, 293}332. Fama, E., Jensen, M., 1983. Separation of ownership and control. Journal of Law and Economics 26, 301}326. Giammarino, R., Lewis, T., 1988. A theory of negotiated equity "nancing. Review of Financial Studies 9, 265}288. Hansen, R., 1988. The demise of rights issues. Review of Financial Studies 1, 289}309. Hansen, R., Pinkerton, J., Ma, T., 1986. On the rightholder's subscription to the underwritten rights o!ering. Journal of Banking and Finance 10, 595}604. Heinkel, R., Schwartz, E., 1986. Rights versus underwritten o!erings: an asymmetric information approach. Journal of Finance 41, 1}18. Kang, J., Stulz, R., 1996. How di!erent is Japanese corporate "nance? An investigation of the information content of new security issues. Review of Financial Studies 9, 109}139. Kothare, M., 1997. The e!ects of equity issues on ownership structure and stock liquidity: a comparison of rights and public o!erings. Journal of Financial Economics 43, 131}148. Lee, I., Lochhead, S., Ritter, J., Zhao, Q., 1996. The costs of raising equity. Journal of Financial Research 19, 59}74. Marsh, P., 1979. Equity rights issues and the e$ciency of the U.K. stock market. Journal of Finance 34, 839}862. Marsh, P., 1980. Valuation of underwriting agreements for U.K. rights issues. Journal of Finance 35, 693}716. Masulis, R., Korwar, A., 1986. Seasoned equity o!erings: an empirical investigation. Journal of Financial Economics 15, 91}118. McConnell, J., Servaes, H., 1990. Additional evidence on equity ownership and corporate values. Journal of Financial Economics 27, 595}612. Mikkelson, W., Partch, M., 1986. Valuation e!ects of security o!erings and the issuance process. Journal of Financial Economics 15, 31}60. Mikkelson, W., Partch, M., 1988. Withdrawn security o!erings. Journal of Financial and Quantitative Analysis 23, 119}134. Miller, M., Rock, K., 1985. Dividend policy under asymmetric information. Journal of Finance 40, 1031}1051. Morck, R., Shleifer, A., Vishny, R., 1988. Management ownership and market valuation: an empirical analysis. Journal of Financial Economics 20, 293}315. Myers, S., Majluf, N., 1984. Corporate "nancing and investment decisions when "rms have information that investors do not have. Journal of Financial Economics 13, 187}221. Parsons, J., Raviv, A., 1985. Underpricing of seasoned issues. Journal of Financial Economics 14, 377}397. Pound, J., 1988. Proxy contests and the e$ciency of shareholder oversight. Journal of Financial Economics 20, 237}265. Shleifer, A., Vishny, R., 1986. Large shareholders and corporate control. Journal of Political Economy 94, 461}488. Singh, A., 1997. Layo!s and underwritten rights o!ers. Journal of Financial Economics 43, 105}130.

190

M.B. Slovin et al. / Journal of Financial Economics 57 (2000) 157}190

Slovin, M., Sushka, M., 1993. Ownership concentration, corporate control activity, and "rm value: evidence from the death of inside blockholders. Journal of Finance 48, 1293}1321. Smith, C., 1977. Alternative methods for raising capital: rights versus underwritten o!erings. Journal of Financial Economics 5, 274}307. Stulz, R., 1988. Managerial control of voting rights: "nancing policies and the market for corporate control. Journal of Financial Economics 20, 25}54. White, R., Lusztig, P., 1980. The price e!ects of rights o!erings. Journal of Financial and Quantitative Analysis 15, 25}40.