Handbook of Corporate Finance Empirical Corporate Finance Volume 1

Ch. 6: Security Offerings 309

Ta b l e 1 2

Predicted market reactionARto SEO announcements as a function of the flotation method choice

Study Model specifics Model implications forAR

Myers and Majluf (1984) Direct sale to public with no
communication between firm and
market. Current shareholders are
passive bystanders to issue (they
neither purchase new nor sell old
shares). Managers maximize
current shareholders’ claim on
firm, which amounts to maximizing
the intrinsic (full-information)
value of this claim

Separating equilibrium:ARdo<0.

Ceteris paribus,ARdois more

negative the greater the risk that the

security is overvalued by market prior

to the issue announcement. A pooling

equilibrium (ARdo=0) is more

likely the greater the ratiob/E(a)

Krasker (1986) Myers and Majluf (1984)but with
varying investment sizeI

In the separating equilibrium,

ARdo<0 and more negative the

greater isI

Heinkel and Schwartz (1986) Issuers choose between uninsured
rights, standbys and firm
commitment offerings. Standbys is
the most expensive flotation
method and provide perfect quality
certification. Firm commitment is
simply a direct sale to market with
no certification

Highest-quality issuers select

standbys, intermediate-quality issuer

select uninsured rights, while lowest

quality issuers select firm

commitments.ARfc<ARur<0and

ARsr> 0

Giammarino and Lewis
(1988)

Myers and Majluf (1984)but with

an intermediary ‘financier’ who

may reject the issue

Semi-separating equilibrium with

ARfc> 0

Eckbo and Masulis (1992) Myers and Majluf (1984)but
allowing current shareholder
takeup of the (exogenous) fraction
kof the issue, and informative but
noisy quality certification by
underwriters. Single-stage flotation
method game

Optimal flotation method choice

depends onk: Separating equilibrium

where no low-kfirms select uninsured

rights. Adverse selection greatest for

firm commitments, lowest for

uninsured rights, with standbys in

between:ARfc<ARsr<ARur 0

Cooney and Kalay (1993);
Wu and Wang (2005, 2006a)

Myers and Majluf (1984)but with

possible managerial

overinvestment (b<0)

Separating equilibrium with

ARdo>0 due to prior market

uncertainty aboutb< 0

Bøhren, Eckbo, and
Michalsen (1997)

Eckbo and Masulis (1992)with

uninsured rights and standbys only,

but with varying underwriter

quality certification

(“effectiveness”)

High-kissuers select uninsured rights

regardless of firm quality, so no

adverse selection (ARsr=0).

Adverse selection in standbys if

underwriter “ineffective” (ARsr<0),

but positive selection if underwriter

“effective” (ARsr>0)

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