Operating Performance of the Firms Issuing Equity through Rights Offer

Abstract

Rights equity issue is one of the most common methods for subsequent equity issue in the Indian market. In rights offer, current shareholders are given short-term warrants on a pro-rata basis with the option to either purchase the new shares or sell the warrants in the market before expiration. Rights equity issue can be a potential solution to the adverse selection problem associated with capital issue and has comparatively low direct costs. In this paper, the authors analyse the operating performance of the BSE- listed manufacturing firms following rights equity issue and their linkages with firm-specific characteristics as hypothesized in the finance theory. They have selected 392 rights equity issues during the period 1991-2000 and used a methodology robust to the mean-reverting nature of accounting income. Consistent with empirical results for seasoned equity offerings in the US market, there is a statistically significant decline in the operating performance after the rights equity issue. This decline in performance is more severe for big firms, low market-to-book value firms, and firms with lower directors' holdings. Interestingly, foreign companies and companies belonging to small business groups do not show any declining trend. The authors find that the decline in perform- ance is due to the inefficiency in utilization of assets and not due to decrease in profit margins. Further, various proxies measuring market valuation also decline during the post-issue period after a run up in the pre-issue period. The results of the study suggest that over-investment hypothesis and agency models can better explain the decline in performance compared to asymmetric information hypothesis. The results also indicate that rights equity issues are not simple de-leveraging decisions. These findings have implications for several groups of capital market participants and the authors conclude with specific guidelines for them which are as follows: The investing public and analyst who are too optimistic about the issuers should consider deteriorating performance while arriving at the valuations. Investors should be vigilant about the ‘empire building’ implications of increased investments through rights issue. Optimistic managers should reassess the investment opportunities and have con-servative plans before approaching the market. The policy makers and regulators should come out with better regulatory framework to control and penalize the opportunistic managers.

Portfolio-based benchmarks and the long-term performance of SEOs for an emerging market

“…Some studies focused on specific issues of SEOs, e.g. the book-building process for the years 1999-2007 (Kumar 2007), the operating performance after issuance for 1991-2000 (Lukose, Rao 2003), the choice between qualified institutional placements and rights issues for 2006-2010 (Tuli, Shukla 2014) or short-term (-30;+30 day event window) price reaction to an announcement of a rights issue for 1997-2005 (Marisetty, Marsden, Veeraraghavan 2008).…”

The Choice between QIP and Rights Issue: Evidence from India

“…In the post-liberalization period, Marisetty, Marsden and Veeraraghavan (2006) find a positive but not a significant price reaction to the announcement of rights issue in general and when they study the family group affiliation, the announcement returns become negative and significant for the firms with high family group affiliation. In another study, Lukose and Rao (2003) report that the operating performance of the firms significantly declines after the rights issue and the decline is more severe for large firms and the firms with low director's holdings.…”

Rights Offering and Its Effect on Share Price Movement: A Study of Commercial Banks

“…The result of the study contrasts with the theory, which says that the share price increases after the right announcement and decreases after the issue of right share. Lukose and Rao (2003) and Heron and Lie. (2004) stated management issue new shares only when the market overvalues the shares.…”