Stock-for-Debt Swaps and Shareholder Returns

Finnerty, John D.

doi:10.2307/3665054

Cited by 22 publications

(13 citation statements)

References 15 publications

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“…Studies of noncash offerings include exchange offers (Masulis, 1980;Masulis, 1983;Pinegar and Lease, 1986) and private swaps (Finnerty, 1985;Peavy and Scott, 1985;Rogers and Owers, 1985). More recent work (Copeland and Lee, 1991;Cornett and Travlos, 1989) is on both exchange offers and swaps.…”

Section: A Stock Offering Findingsmentioning

confidence: 99%

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Bank Debt Reduction Announcements and Negative Signaling

Hull¹,

Moellenberndt²

1994

Financial Management

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We examine 242 NYSE/AMEX and OTC common stock offerings that reduce bank debt and 254 that retire nonbank debt. We discover that bank debt reductions are associated with negative announcement period stock returns that are more than twice the magnitude of the negative returns found for nonbank debt reductions. The significant difference in returns indicate bank debt reductions transmits negative information beyond that previously cited in the stock offering literature. Regression tests show that the explanatory variable representing bank debt signaling models best explains stock returns.█ Bankers are parties to information about a firm's financial condition through their special relationship as lenders. This premise is the basis for the predictions of bank debt signaling models, which posit that bank debt issuance announcements convey positive news about a firm. Empirical research on debt offering announcements that raise cash for multi-corporate purposes supports this claim. The research documents statistically significant positive stock price reactions to bank debt announcements and negative reactions to nonbank debt announcements.If bank debt issuance announcements signal more favorable news than nonbank debt announcements, it follows that bank debt reduction announcements should signal more negative news than nonbank debt reduction announcements. Market participants will view bank debt reduction announcements as the result of decisions made by bankers acting upon unfavorable inside information.Our study extends prior research on equity offerings that reduce debt. We analyze 242 stock offering announcements that reduce bank debt, and 254 announcements that retire nonbank debt. Consistent with the predictions of bank debt signaling models, returns for bank debt reductions are more negative than returns for nonbank debt reductions, and the differences in returns are statistically significant. I. Competing Capital Structure ModelsEvent study research finds a significant negative stock valuation effect for equity-for-debt transactions such as exchange offers, private swaps, and stock offerings that raise cash to reduce debt. These findings are consistent with capital structure models that predict negative tax, agency, and signaling effects.Tax models, rooted in Modigliani and Miller (1963), hypothesize negative stock price behavior from lost tax shields when firms undergo stock-for-debt transactions. Agency models that deal with risk shifting, such as the intrasecurity wealth transfer model of Galai and Masulis (1976), also hypothesize negative stock price behavior. The cash flow payments to debtholders become less risky, while payments to stockholders become more risky. This causes wealth transfers from stockholders to debtholders.Asymmetrical information models (e.g., Leland and Pyle (1977) and Ross (1977)) predict that stock-for-debt transactions signal negative news. Leland and Pyle connect negative signaling to decreases in the percentage of inside ownership caused when insiders do not participate in the stoc...

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Section: A Stock Offering Findingsmentioning

confidence: 99%

“…The seven independent variables for which results are reported are described below. Some variables are unique to this study; others are similar to those used in prior research (Asquith and Mullins, 1986;Cornett and Travlos, 1989;Finnerty, 1985;Masulis and Korwar, 1986).…”

Section: A Explanatory Variablesmentioning

confidence: 99%

Bank Debt Reduction Announcements and Negative Signaling

Hull¹,

Moellenberndt²

1994

Financial Management

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“…Private swaps (which are typically undertaken by large firms) not only have a smaller impact on stock value due to lower issue costs (e.g., see Hand, 1989;and Rogers and Owers, 1985), but also have a smaller mean two-day CAR. The CAR is usually near or below -1.0% (e.g., see Copeland and Lee, 1991;Finnerty, 1985;and Peavy and Scott, 1985). Ceteris paribus, one would expect a smaller mean CAR if issue costs are lower.…”

Section: B Issue Costsmentioning

confidence: 99%

Issue Costs and Common Stock Offerings

Hull¹,

Kerchner²

1996

Financial Management

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Prior research of common stock offerings reaches different conclusions concerning the impact of issue costs on stock value. We identify factors that can best explain the different findings-most prominent are the issue costs measure and the listing. We investigate 323 common stock offerings and find that $61 of every $100 fall in stock value can be attributed to issue costs. The respective dollar amounts for the samples of OTC, AMEX, and NYSE firms are $72, $69, and $38. These findings suggest that the collective impact of the negative wealth effects from managerial signaling may be less important than generally assumed. Mikkelson and Partch (1986) and Hull andFortin (1993/1994) are the only studies to examine in detail the impact of issue costs on announcement period stock returns for equity offerings. These two studies reach different conclusions. Mikkelson and Partch (1986) find that offering costs are a relatively small portion of the negative announcement period return, while Hull andFortin (1993/1994) show otherwise. This disagreement motivates our research as we aim to explain the different conclusions concerning the wealth impact of issue costs. In the process we hope to understand the situations for which issue costs can significantly impact common stock value.We begin our research by examining the literature in order to discover factors that can help explain the different conclusions. We identify four potentially relevant factors: the measure of issue costs; the listing of the firms in the sample; the percentage change in outstanding common stock caused by the new offering; and the inclusion or exclusion of combination offerings.We select a sample of 323 common stock offerings and investigate this sample in light of the above four factors. First, we use (for the most part) an issue costs measure that is a compromise between those used by the two prior studies. This measure includes cash flotation costs (consisting of the underwriting spread and fees associated with administration, registration, and legal services) and underpricing. The use of the term "cash" captures the fact that these costs cause an immediate cash compensation for investment bankers. Second, in our analysis, we include an examination of samples of OTC (n=106), AMEX (n=107), and NYSE (n=110) firms. Third, we screen out issues that involve very small changes in common shares (and for which an issue costs effect is not of economic significance). Finally, we investigate both primary and combination offerings. We summarize our results when cash flotation costs and underpricing are used to measure issue costs. When testing our total sample, we find that the average fall in common share value that can be attributed to issue costs is -1.59%, as compared to the average twoday fall in stock value of -2.62%. The mean fall in stock value represents 61% of the mean fall in stock value.1 Like others (e.g., Hull andFortin, 1993/1994;and Hull and Moellenberndt, 1994), we classify an observation as a combination offering when the primary component of ...

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“…A review of the press announcements of exchanges suggests that some managers undertook these transactions because of the immediate accounting changes that occur in the income statement and balance sheet, specifically, an increase in earnings for the current 3Finnerty [8] provides a description of the institutional and tax details of exchanges.…”

Section: Valuation Implicationsmentioning

confidence: 99%

“…Generally, the gain is extraordinary if the scheduled maturity date is more than one year beyond the repurchase date. 5Finnerty [8] presents an extensive analysis of the valuation consequences of equity for debt exchanges, providing the insights of an investment banker. A number of his observations were helpful in the development of this section.…”

Section: Valuation Implicationsmentioning

confidence: 99%