Raising Capital Theory and Evidence
Introduction
New information announcements about security offerings by publicly listed firms can cause one of three reactions in the financial markets: (i) positive, (ii) negative, or (iii) indifferent reactions. These responses are measured in the average two-day common stock price reactions adjusted for general market price changes (abnormal returns) to announcements of public issues of common stock, preferred stock, convertible preferred stock, straight debt and convertible debt. Stock markets react to such news by adjusting the market value of the company either upwards or downwards. to take account of the newly announced information.
In 1986, Clifford W. Smith Jr., took note of some very important patterns about the stock market’s reactions security offerings and explored them through his article entitled Raising Capital: Theory and Evidence. His primary finding was that, on average, announcements either lead to reductions in the market valuations of companies issuing securities or being ‘insignificantly different from zero.’ Furthermore he noted that there is usually no significant positive reaction to the valuation of a company as a result of a new security offer announcement.
His findings also differentiated and drew correlations among the types of security offerings and the intensity of market response. The stock market’s reaction to common stock offers was ‘more strongly negative’ than when preference stock and debt capital was issued. As a senior claim to common stock, it could be argued that issuing debt capital communicates information about management’s confidence in the firm to the financial markets. Smith also observed that stock markets react more unfavorably to announcements of issue of convertible loans when compared to issuance of non convertible loans. Given the characteristics of convertible loans, which contain elements of common stock, these negative reactions seemed to fit the general pattern of findings.
Once a firm has decided on
New information announcements about security offerings by publicly listed firms can cause one of three reactions in the financial markets: (i) positive, (ii) negative, or (iii) indifferent reactions. These responses are measured in the average two-day common stock price reactions adjusted for general market price changes (abnormal returns) to announcements of public issues of common stock, preferred stock, convertible preferred stock, straight debt and convertible debt. Stock markets react to such news by adjusting the market value of the company either upwards or downwards. to take account of the newly announced information.
In 1986, Clifford W. Smith Jr., took note of some very important patterns about the stock market’s reactions security offerings and explored them through his article entitled Raising Capital: Theory and Evidence. His primary finding was that, on average, announcements either lead to reductions in the market valuations of companies issuing securities or being ‘insignificantly different from zero.’ Furthermore he noted that there is usually no significant positive reaction to the valuation of a company as a result of a new security offer announcement.
His findings also differentiated and drew correlations among the types of security offerings and the intensity of market response. The stock market’s reaction to common stock offers was ‘more strongly negative’ than when preference stock and debt capital was issued. As a senior claim to common stock, it could be argued that issuing debt capital communicates information about management’s confidence in the firm to the financial markets. Smith also observed that stock markets react more unfavorably to announcements of issue of convertible loans when compared to issuance of non convertible loans. Given the characteristics of convertible loans, which contain elements of common stock, these negative reactions seemed to fit the general pattern of findings.
Once a firm has decided on
References: Avner Kalay and Adam Shimrat, “Firm Value and Seasoned Equity Issue: Price Pressure, Wealth Redistribution, or Negative Information,” New York University 1986. Clifford W. Smith, “Alternative Methods for Raising Capital: Rights versus Under-Written Offerings,” Journal of Financial Economics 5 (1973), 273-307. Clifford W. Smith, “Raising Capital: Theory and Evidence,” Journal of Financial Economics 5 (1986). Katherine Schipper and Abbie Smith, “A Comparison of Equity Carve-Outs and Seasoned Equity Offerings: Share Price Effects and Corporate Restructuring,” Journal of Financial Economics 15 (1986), pp.153-186. Scholes, “Market for Securities: Substitution versus Price Pressure and the Effects of Information on Share Prices,” Journal of Business 45 (1972), 179-211. Scott Lian and J. Michael Pinegar, “The Effect of Issuing Preferred Stock on Common Stockholder Wealth,” University of Iowa, 1985.