Seasoned Equity Offerings, Corporate Governance, and Investments (Digest Summary) (2024)

What’s Inside?

To explain adverse investor reactions to corporate announcements of seasoned equityofferings (SEOs), the authors use a difference-in-differences statistical test to focus onsituations that are unfavorable for good governance. Such situations involve businesscombination statutes (BCS) that reduce the likelihood of corporate takeovers. The authorsconclude that in such contexts, SEOs implemented to pursue acquisitions can be discouragingto investors because they view such SEOs as potentially unproductive. Market reaction ismore negative for issuers with a weak history of executing value-enhancing mergers and withweaker managerial wealth sensitivity to shareholder value as evidenced in compensationpolicies. These governance effects are surprisingly large, accounting for most of thepreviously identified unfavorable market appraisal of primary SEOs.

How Is This Research Useful to Practitioners?

The authors make their research relevant for practitioners by connecting such timely topicsas the validity of “build versus buy” for business development, the relationshipbetween governance and managerial motivation, and the efficacy of shareholder activism inlight of regulatory change. They sidestep the debate on expectations, as summarized by thesingle metric of market to book value and its signaling effect for high-growthopportunities. Instead, they focus on constraints arising from agency issues, with theevolving governance framework as the medium for the alignment of interests between managersand owners, and address both sides of the related issues.

For investors, the authors model fairly precise cost estimates of both antitakeover rulesand incumbent managers who are ineffective at acquisitions. These two investment hurdlesresult in an approximate sacrifice of total returns of 2% and 1.2%, respectively. Forcorporate managers seeking external financing, the authors estimate an increased cost of7.4%–9.2% of the total proceeds raised when their firms are perceived as being alignedwith internal self-interest. These detrimental financing costs are exacerbated whensecondary share offerings from management are accompanied by a primary SEO event. And forboth investors and insiders, the related drawbacks are experienced fairly quickly, with thebulk of the effect concentrated in the year following BCS enactment.

How Did the Authors Conduct This Research?

The authors rely on multiple data sources—including the Thomson Reuters SDC,ExecuComp, Compustat, and CRSP databases—to track primary share offerings by US firmsin the period of 1982–2006, concentrating on a given year’s first SEO whenmultiple offerings are made annually. Solely secondary offerings are excluded. Regressionmodels are applied within the shorter period of 1982–1990, when there were activeefforts in 28 states to enact BCS rules limiting takeovers, resulting in a final test sampleof 1,066 SEOs.

Their statistical method is a difference-in-differences approach that portrays BCS as anexternal shock that weakens corporate governance. Their approach has two stages: The firstis studying the BCS enactment effect around the period of the announcement (filing date),and the second is estimating the interactive effect of capital expenditure increases(defined as acquisitions) and the BCS in the given year of SEOs as an expost proxy for weak governance. Benchmarks for the acquisition history ofcorporate issuers are calculated to determine the related effectiveness of management.Allowance is made for the state of incorporation (with special attention to Delaware), butno special geographic effect is identified.

Complementing the primary analysis of the SEO–BCS interaction, the deltas of thefirms’ top managers (i.e., the sensitivity of the value of their firm stockholdings tochanges in the firm’s stock price) are calculated to determine the effect of wealthsensitivity on returns. The models also undergo robustness tests, which confirm there are nosignificant omitted variables.

Abstractor’s Viewpoint

With shareholder activism becoming an increasingly prominent investment strategy and withinvestors who follow more traditional approaches experiencing increased attention on theirproxy voting, the impact that governance choices have on returns is not merely hypothetical.The authors provide evidence for the proposition that “voting with one’sfeet” can be hazardous to one’s wealth and that legislated adjustments toimprove the market for corporate control are accompanied by real, if subtle, costs. Absentsuch interventions and given the stewardship of empathetic management, existing investorsare not troubled by the prospect of dilution from an expanded equity base.