Rational Financial Management: Evidence from Seasoned Equity Offerings

Barclay, Michael J.; Fu, Fangjian; Smith, Clifford W.

doi:10.2139/ssrn.1099850

Cited by 10 publications

(14 citation statements)

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“…As a result, the monitoring of large shareholders diminishes and managers have less incentive to abstain from overinvestment. Additionally, equity offerings increase the firm's public float enhancing the manager's ability to raise additional capital through borrowing (Barclay, Fu, and Smith, 2009).…”

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Overinvestment and the Operating Performance of SEO Firms

2010

Financial Management

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Prior studies have documented that firms' operating performance deteriorates following seasoned equity offerings (SEOs) Previous studies have documented that firms' operating performance deteriorates following seasoned equity offerings (SEOs). Meanwhile, the postissue stock returns of SEO firms are inordinately low relative to various benchmarks of expected returns.1 A popular explanation seems to be managers' timing the market where their decision of SEO is in anticipation of poor future performance. In this paper, I present an overinvestment explanation for poor firm performance after SEOs. Managers' overinvestment of SEO proceeds leads to this poor performance. More specifically, I find that controlling for the differences in industry, investment opportunities, and financial slack, SEO firms still invest more heavily than nonissuing firms and this excess investment is negatively related to postissue operating performance. Further evidence indicates that overinvestment significantly reduces the asset productivity of SEO firms.Why do managers of SEO firms overinvest after equity offerings? Jensen (1986Jensen ( , 1993 argues that managers have various incentives to grow their firm beyond the optimal size. They can enjoy more private benefits by managing a larger firm and their compensation is dependent upon asset growth rather than profitability. Seasoned equity offerings are an effective way to grow firm size. For example, the average SEO proceeds in my sample are 24% of the issuing firm's market value and they are all cash. The probability of overinvestment increases with free cash flow under managers' control.

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Overinvestment and the Operating Performance of SEO Firms

2010

Financial Management

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“…We propose in this paper that the factor‐analysis approach in extracting the information about common shifts in accounting items (observable by investors) is a useful tool in measuring shifts in corporate financial flexibility that are observable by rational investors who make the best use of information from balance sheets. As will be shown in the later sections, the FFLEX factor documented in our paper effectively reflects shifts in financial flexibility in the spirit of Barclay, Fu and Smith () model—the proactive equity issuances and simultaneous buffer cash holdings. To the extent that FFLEX proxies for corporate financial flexibility observed by investors, we hypothesize that H1 : Future stock returns of firms (year t + 1 ) are associated with their current‐year shifts in FFLEX (year t) . …”

Section: The Value Of Corporate Financial Flexibility and Its Impact mentioning

confidence: 65%

“…Importantly, they show that sample firms would not have met such major and sudden financial needs without the tapping of accumulated financial flexibility. Related to our study, Barclay, Fu and Smith () advocate proactive equity issuances as another important tool in building up financial flexibility. They document that large seasoned equity offerings (SEO) tend to move firms’ leverage below the long‐term target debt ratio.…”

Section: The Value Of Corporate Financial Flexibility and Its Impact mentioning

confidence: 78%

“…They have low leverage, unused debt capacity (which will be improved even further), and substantial cash balances. Barclay, Fu and Smith () also document that these firms actually increase and maintain the higher level of capital expenditures for two years after SEO activities.…”

Section: The Value Of Corporate Financial Flexibility and Its Impact mentioning

confidence: 92%

“…It is the first principal factor (out of five natural latent factors) that consists of components such as simultaneous shifts in common equity‐total, common equity‐liquidation, cash and equivalents, and common equity‐tangible scaled by lagged total assets. The positive simultaneous shifts of these items reflect a conserving of financial flexibility through proactive equity issuances as in the Barclay, Fu and Smith () model. Specifically, cash balances surge (Denis, ) through equity issuances (Byoun, ) and the accumulation of liquidation capital (Gamba and Triantis, ), even among firms that are far from being financially constrained.…”

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Is Financial Flexibility a Priced Factor in the Stock Market?

Rajput

Wongchoti

Chen

et al. 2019

The Financial Review

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This paper develops a factor analysis–based measure for shifts in corporate financial flexibility (FFLEX) that can be observed from public accounting information. Companies that experience positive shifts in FFLEX are associated with higher future investment growth opportunities. We show that FFLEX is a robust determinant of future stock returns. Firms that have increased their financial flexibility are associated with lower stock returns in the subsequent period. A zero‐cost return portfolio produces a significant positive monthly premium of 0.69%, which is driven by covariance (risk). Risk inherent in the flexibility factor is not explained away by either prominent pricing characteristics or factors.

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The Response to Share Mispricing by Issuing Firms and Short Sellers

Schultz

2022

J. Financ. Quant. Anal.

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Short sale constrained stocks are overpriced on average. I show that firms exploit mispricing by selling shares when their stock is short sale constrained and repurchasing shares when their stock is easily shorted. Stocks underperform following seasoned equity offerings (SEOs) if and only if the stock is difficult to short. This suggests that some SEOs are motivated by mispricing, whereas others are not. Short selling costs make it difficult for investors to profit from the poor performance following SEOs. Short selling and SEOs are alternative ways to supply shares to investors, and firms become the low-cost share provider when short selling is costly.

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Rational Financial Management: Evidence from Seasoned Equity Offerings

Cited by 10 publications

References 58 publications

Overinvestment and the Operating Performance of SEO Firms

Overinvestment and the Operating Performance of SEO Firms

Is Financial Flexibility a Priced Factor in the Stock Market?

The Response to Share Mispricing by Issuing Firms and Short Sellers

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