Faculté des sciences économiques et sociales

Seasoned equity offerings and their impact on the firm value

Jeanneret, Pierre ; Dubois, Michel (Dir.)

Thèse de doctorat : Université de Neuchâtel, 2003 ; 1714.

The literature about capital structure is very dense but this density does not lead to establish a clear relation between capital structure and firm value. The seminal work of Modigliani and Miller (1958) states that under perfect market conditions, the capital structure choices are irrelevant to the firm value. This proposition cannot hold when market frictions are introduced in the analysis.... Plus

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    Summary
    The literature about capital structure is very dense but this density does not lead to establish a clear relation between capital structure and firm value. The seminal work of Modigliani and Miller (1958) states that under perfect market conditions, the capital structure choices are irrelevant to the firm value. This proposition cannot hold when market frictions are introduced in the analysis. From a theoretical standpoint, two main streams of models can be distinguished. First, trade-off models examine the existence of an optimal repartition between debt and equity. They are based on the hypothesis that the cash flows cannot be fully and symmetrically returned to every investors' type because of bankruptcy costs, corporate and individual taxes and characteristics of the output market (level of competition, production techniques and product specificities). Under these circumstances, firms can gain value in managing their capital structure. The repartition between debt and equity is said to be optimal when it maximises the firm value. However, this relation remains difficult to test empirically. The second theoretical stream is based on the hypothesis that market frictions prevent individual investors and market intermediaries to re-design efficiently and costlessly any financial assets. Therefore, firms have an incentive to issue specific securities to minimise the market imperfections impact on their value. Information asymmetry, agency costs, timing, flotation methods and underwriter's certification become the main determinants of the capital structure choices and they are better suited to explain the impact of these choices on the firm value. Unfortunately, the empirical literature lacks to clearly relate explanatory variables to the theory they should refer to. The dissertation proposes two empirical studies that examine the relation between equity financing and firm value, one at the announcement of the equity offering, the other over a long-term horizon. One contribution is to introduce the intended use of the proceeds as a discriminating variable to separate offerings realised in order to finance a specific investment project from those made to improve the capital structure. In both frameworks (short-term after the offering announcement and long-term post-issue horizon), the results in terms of valuation effect are sensitive to the issuer's type. A negative impact is observed but it is restricted to issuers that finance a new investment project. This valuation effect is explained by information asymmetry and timing on the short-run and by model uncertainty on the long-run. It is caused by an expected decrease in future earnings since financial analysts adjust their earnings forecasts downwardly short after the announcement or over a longer-term horizon. One explanation could be that investment projects financed with equity are, first, high-risk with a negative net present value and second, the market is unable to correctly estimate the impact on the firm value at the issue announcement. It needs time to infer the true model parameters so that it may adjust its anticipation about the stock prices correctly. Re-balancing the capital structure has no significant impact on the firm value. The main conclusions can be summarised as follows. First, the intended use of the proceeds allows to differentiate equity issue in terms of valuation effect and of the theories that explain this valuation effect. Second, valuable private information is revealed at the offering announcement. Third, the long-term stock under-performance after the offering is not due to investors' irrationality but to model uncertainty. Fourth and finally, almost half of the equity issues are made in order to improve the capital structure, which is consistent with the American and European CFOs' opinion that their financial policy is mainly driven by the concern of preserving their financial flexibility. Our results show that working on that financing flexibility has no impact on the firm value, as predicted by Modigliani and Miller (1958).