12: Raising Long-Term Financing
Seasoned ordinary equity issues must generally follow the same regulatory and underwriting
procedures as unseasoned offerings. Seasoned offerings differ from unseasoned ones not just because of
the former’s large average size but also, and principally, because seasoned securities have an observable
market value when the offering is priced, which obviously makes pricing much easier. Studies show that
American SEOs tend to be priced very near the current market price. However, ease of pricing does not
mean that investors welcome new equity offering announcements, as we now discuss.
12- 4a SHARE PRICE REACTIONS TO SEASONED EQUITY
OFFERINGS
One reason why corporations issue seasoned equity very rarely is that share prices usually fall when
firms announce plans to conduct SEOs. On average, the price decline is about 3%. In the US, the
average dollar value of this price decline is equal to almost one-third of the dollar value of the issue
itself. Clearly, the announcement of seasoned equity issues conveys negative information to investors
overall, though precisely what information is transmitted is not always clear. The message may be that
management, which is presumably better informed about a company’s true prospects than are outside
investors, believes the firm’s current share price is too high. Alternatively, the message may be that the
firm’s earnings will be lower than expected in the future and management is issuing equity to make up
for the internal cash flow shortfall.
There is some evidence that SEOs are bad news for shareholders, not only at the time they are
announced but also over holding periods of one to five years. Negative long-run returns following
Why are firms typically
reluctant to use seasoned
equity offerings (SEOs) to raise
long-term funds?
thinking cap
question
FIGURE 12.6 FACTORS THAT AFFECT SEO ISSUANCE DECISIONS – CFO SURVEY EVIDENCE
0% 10% 20% 30% 40% 50% 60% 70%
Per cent of CFOs identifying factor as important or very important
Favourable investor
impression vs. issuing debt
Similar amount of
equity as same-industry firms
Sufficiency of recent
profits to fund activities
Stock is our ‘least risky’
source of funds
Diluting holdings
of certain shareholders
Maintaining target
debt/equity ratio
Providing shares to employee
bonus/option plans
If recent stock price increase,
selling price ‘high’
Magnitude of equity
undervaluation/overvaluation
Earnings per share dilution
Source: Reprinted from John R. Graham and Campbell Harvey, ‘The Theory and Practice of Corporate Finance: Evidence from the Field’,
Journal of Financial Economics, 60, pp. 187–243, copyright © 2001, with permission of Elsevier.