282 B.E. Eckbo et al.
3.5. Offering delays and withdrawals
Another component of expected flotation costs is the costs of bearing most of the out
of pocket expenses associated with preparing a security offering without realizing the
benefits of actually raising capital due to an offering cancellation. In addition, this capi-
tal short fall can have adverse implications for a firm’s ability to pursue the positive net
present value projects that it has available to it and may have a negative effect on the
timing, size and pricing of a subsequent security offering. Interestingly, several early
studies byMikkelson and Partch (1986)andOfficer and Smith (1986)reported that
announcements of SEO withdrawals are greeted by a positive market reaction. Examin-
ing both SEO and convertible debt withdrawals,Jensen and Pugh (1995)report similar
positive stock reactions.Altinkilic and Hansen (2006)report that SEO withdrawals are
preceded on average by a precipitous stock price drop of 17 percent. To the extent that
offer cancellation has negative implications for the firm’s financial condition and the
size of flotation costs and its ability to pursue investment projects, this positive price re-
action suggests that the market was skeptical about the profitability of the firm’s planned
investment projects or else was concerned that the reason for the stock offer was that
the stock was seriously overvalued, following the logic ofMyers and Majluf (1984).
Edelen and Kadlec (2005)explore the implications of the risk of offer cancellation
on the pricing of the offering. They observe that as offer price discount rises the risk
of offer cancellation falls. This can explain why issuers are willing to go forward with
offerings that they know are underpriced and why positive information released between
the filing and offering dates is only partially incorporated into the final offer price as
documented byHanley (1993). Taking into account that some firms will have greater
need for funds than others, and that new public information about the stock’s value will
vary across offerings, they are also able to develop a model to predict which offers will
be more underpriced. In estimating the probability of offer withdrawal using a probit
model, they find that it is significantlypositivelyrelated to industry returns between
the filing and offering date, prior IPO initial returns (30 days), log of the offer size,
and withdrawals of earlier IPOs and significantly negatively related to prior IPO offer
price revisions between the filing and offering dates (prior 30 days), and underwriter
rank.
3.6. Underwriter competition
There is conflicting evidence on whether the market for underwriter services is highly
competitive or oligopolistic.Chen and Ritter (2000)argue that the high frequency of
7 percent underwriter spreads in IPOs is evidence that this market is far from per-
fectly competitive.Hansen (2001)reports a number of pieces of evidence about the
IPO process that supports the contention that this market is highly competitive, such
as an IPO with 7 percent underwriter spread does not contain abnormal profits relative
to other IPOs, that there is no evidence of monopoly profits in underpricing or unusual
charges in subsequent SEOs, and that the 7 percent contract has persisted despite the