SEASONED EQUITY ISSUERS’ R&D INVESTMENTS: SIGNALING OR OVEROPTIMISM

Abstract

It is well known that investors often react negatively to the announcements of seasoned equity offerings (SEOs). We posit that issuers can use positive discretionary (higher than expected) R&D investments before the SEO to signal their investment prospects to mitigate the negative announcement effect. Alternatively, positive discretionary R&D may be attributed to managerial overoptimism about future returns of R&D investments. We find strong support for the signaling hypothesis among high-tech issuers: investors respond more favorably to the SEO announcements of high-tech issuers with positive discretionary R&D; these issuers are more likely to use new capital in future R&D and they produce better post-SEO operating performance. In contrast, we find some evidence of managerial overoptimism among low-tech issuers: investors tend to penalize low-tech firms with positive discretionary R&D at SEO announcements; they are more likely to hold new capital as cash and they fail to produce better post-SEO operating performance.

SEO valuation and insider manipulation of R&D

“…Rangan (1998) considers discretionary accruals, and finds that the market temporarily overvalues SEO firms and is subsequently disappointed by predictable declines in earnings caused by earnings management. Qian et al (2012), one of the most closely related to our paper, find that investors respond more favorably to the SEO announcements of high-tech issuers with positive discretionary R&D, thereby supporting the signaling hypothesis. In spite of similarities in methodology, our paper is distinct from Qian et al (2012) in that (1) our focus is on the market's reaction to insider ownership and R&D underinvestment, while their focus is on the market's reaction to R&D overinvestment of high-tech and low-tech firms, (2) we offer more detailed analysis of market valuation for various short-run and long-run periods.…”

Corporate R&D spending, subsidies and stock market reactions to seasoned equity offering announcements: evidence from China

“…This may be because information asymmetry is severe in these firms, and a simple signal, such as R&D subsidies, cannot fully curb information problems. Conversely, high-tech can be a signal of good R&D qualities (Qian et al, 2012). Therefore, High-tech strengths the signal effect of R&D subsidies and leads investors to access more R&D information, which further avoids stock mispricing caused by R&D before SEOs.…”

“…Stock market reactions reflect stock market performance influenced by investors' attitudes toward new information, such as SEOs (Carlini et al, 2020). Prior studies have documented that the stock market generally reacts negatively to SEOs, and that this phenomenon can be explained by information asymmetry (Qian et al, 2012;Akhigbe and Whyte, 2015;Opare et al, 2020). Specifically, information asymmetry leads investors to IJOEM 18,11 5380 JEL Classification -G14, G32, G38, O31…”

R&D accounting treatment, firm performance, and market value: Biotech firms case study

“…R&D accounting treatment, firm performance, and market value: Biotech firms case study Meanwhile, spending more R&D investment than market expectation can be interpreted as managers providing a positive signal on future profits and future investment opportunities in a situation where information asymmetry exists (Qian et al, 2012). Qian et al (2012) measure discretionary R&D expenditures to verify the effect of discretionary R&D expenditures and find that discretionary R&D expenditures support the signal hypothesis and not the managerial over-optimism hypothesis. In addition, markets are found to react more favourably to increase in R&D investment of high-tech industry compared to that of low-tech industry (Chan et al, 1990;Eberhart et al, 2004).…”