Market Feedback and Equity Issuance: Evidence from Repeat Equity Issues

Abstract

Higher first-year post-issue returns are associated with a significantly higher probability of follow-on equity issuance over the next 5 years. This result holds when we control for pre-issue returns and other factors known to affect the probability of equity issuance. The result is most consistent with the market feedback hypothesis that a high post-issue return encourages managers to increase the firm’s investment because it implies that, in the market’s view, the marginal return to the project is high.

Do investors learn from the past? Evidence from follow-on equity issues

“…The regressions indicate that both the six-month (Column 1) and one-year (Column 2) returns following an SEO are positively related to the probability of a firm issuing equity again. Hovakimian and Hutton (2010) find similar results, which support the feedback interpretation of returns. The other explanatory variables are generally in line with the predictions of capital structure theory.…”

“…In the first column of Table 5, I introduce an interaction term that takes the value of one for firms that have shares held by institutional investors in the top quartile among all issuers. Hovakimian and Hutton (2010) find that feedback is more important for issuers having more institutional investors, who are generally considered to be more diligent in producing information. Moreover, Field and Lowry (2009) find the institutional investors are also better at interpreting public information.…”

“…This analysis gives preliminary insights into the types of firms conducting SEOs, 8 In the regression analysis I drop issues that do not have data for all the explanatory variables. 9 In comparison, Loughran and Ritter (1995) find that seasoned equity issuers underperform size-matched firms by 6.3% in the first year after an issue, while Hovakimian and Hutton (2010) find that seasoned equity issuers underperform their book-to-market and size matched benchmark by 5.2% in the year after issue. Fig.…”

“…I measure the stock price performance following a SEO as the buy-and-hold abnormal return (BHAR) over a six-month or oneyear period, relative to a benchmark of non-issuers matched on size and book-to-market-value of equity at the end of the fiscal year preceding the offer. 7 Hovakimian and Hutton (2010) and Autore et al (2009) are among several studies that use size and book-to-market benchmarks to calculate abnormal returns. The matching procedure is as follows.…”

“…One interpretation of the abnormal returns following an equity issue is that they represent market feedback about the firm's investment plans, as in Jegadeesh et al (1993) and Hovakimian and Hutton (2010). 15 Under this interpretation, the regression results suggest that investors convey their assessment of poor investment opportunities through post-issue returns and subsequently negotiate a greater discount if the firm returns to the market with a follow-on issue.…”