Doctoral Dissertations

Date of Award

12-1987

Degree Type

Dissertation

Degree Name

Doctor of Philosophy

Major

Business Administration

Major Professor

George C. Phillippatos

Committee Members

Ronald Shrieves, Joe Ogden, Hui Chang

Abstract

The purpose of this dissertation is to contribute to our understanding of the impact of a new common stock issue on the behavior of the stock price. Asquith and Mullins (1986), Masulis and Korwar (1986) and several others document that share prices of industrial firms and public utilities decline by about 3.0% and less than 1.0%, respectively, in response to the announcement of a new common stock issue. Four hypotheses are tested to identify the factors that affect the change in stock price at the announcement (offering) date of a new common stock issue. Managerial ownership hypothesis states that the two-day common stock issue announcement period cumulative abnormal return (CAR) increases as managerial ownership of the firm's common stock increases. Slack abundance hypothesis holds that the decline in stock price, in response to the announcement of a new common stock issue, moderates as the proportional amount of financial slack, included in the financing of the project, increases. Rights versus publicly underwritten offerings hypothesis avers that issuing new shares of common stock through a rights offering results in a smaller drop in stock price than issuing through a publicly underwritten offering. Finally, hypothesis of determining the subscription price in a rights offering maintains that firms while setting the subscription price comply with the theoretical predictions of either the Myers and Majluf (1984) model, which implies that firms resort to low subscription prices to secure the financing of a project, or the Heinkel and Schwartz (1986) model which claims that high quality firms set high subscription prices to distinguish themselves from low quality firms.

The data consist of 352 industrial firms and 625 public utilities; of which 196 were offered through rights offerings over the 1962-1984 period and 781 were offered through publicly underwritten offerings over the 1971-1984 period. The market model is employed to estimate the abnormal returns around the announcement date of a new common stock issue; as in Dann-Mikkelson (1984). The four hypotheses are tested by estimating a cross-sectional regression model where the two-day announcement (offering) period CAR is the dependent variable.

It is found that moderate levels of managerial ownership affect the stock price performance, at the announcement of a new common stock issue in a favorable manner. Extremely high levels of managerial ownership do not bring about the expected desirable outcomes associated with managerial ownership. A negative relationship is obtained between the two-day announcement period CAR and financial slack, at odds with slack abundance hypothesis. We document that stock prices of industrial firms drop by 2.1% in response to the announcement of a new common stock issue through a rights offering versus 3.5% through a publicly underwritten offering; consistent with our hypothesis. In addition, the drop in stock prices of public utilities does not vary significantly across rights offerings (0.73%) and publicly underwritten offerings (0.81%). And, all industrial firms and some public utilities are found to comply with the predictions of the Heinkel and Schwartz (1986) model. However, the remaining public utilities are found to be concerned with the funding of a project as suggested by the Myers and Majluf (1984) model.

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