Issue Costs and Common Stock Offerings

Abstract

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 ...

Leverage Ratios, Industry Norms, and Stock Price Reaction: An Empirical Investigation of Stock-for-Debt Transactions

“…This return is 3.33% more negative than the seven-day return of -0.61% for the 141 "closer to" firms. Adjusting the "closer to" group's return for the negative effects of issue costs, as suggested by Hull and Kerchner (1996), I find a positive (and economically meaningful) return of over +1.5%.…”

“…When comparing the long-run returns between the two groups for this period, I find that the difference of 10.96% is statistically significant at the 0.01 level (t = 3.11 and z = 2.96). This significant difference suggests that "away from" firms require a greater price run-up before they will stray from their 14 Hull and Kerchner (1996) examine 323 NYSE/AMEX/OTC stock-for-debt transactions from 1970 to 1989. They find that the negative wealth effect from issue costs as a percentage of outstanding common stock value is -1.03% if "cash" expenses (the selling concession and other expenses paid directly to underwriters) are considered.…”

Insider signaling and seasoned equity offerings

“…For short‐run abnormal return tests, we also report results when abnormal returns are adjusted for issue costs. The issue costs methodology (Hull and Fortin, 1993; Hull and Kerchner, 1996) involves calculating the expected residual cash outflow of the issue costs being considered (in our case just the “cash” issue costs given by the prospectus and not the “noncash” costs such as underpricing) per outstanding share and adding the absolute magnitude of this outflow to the closing stock price on the registration day, which we assume to be the announcement day (or event day 0). For long‐run abnormal returns, we report results when testing both:…”

“…Even though such effects have merit, this paper largely focuses on how the Leland and Pyle signaling theory's prediction about “changes” in insider ownership levels fares on its own account. However, we do adjust for issuance costs as this line of research (Smith, 1977; Hull and Fortin, 1993; Hull and Kerchner, 1996) suggests that issue costs can account for much of the fall in the announcement period stock price.…”

The calculation of returns during seasoned equity offers

“…An exception is Hull & Kerchner (1996), who argue that a large part of the negative average abnormal return on announcement of US firm-commitments represents the costs of issue. They measure the information effect of the SEO announcement by adding the costs of issue per old share to the prevailing share price at the end of the event window.…”