328 B.E. Eckbo et al.
market reaction to straight debt offerings summarized inTable 16is not statistically
significantly different from zero. As shown byEckbo (1986), even large debt issues—
where the stated use of the proceeds is to fund the firm’s investment program—do not
elicit a positive market response.
Wealth transfer to bondholders. Holding the firm’s investment policy constant, an
equity issue reduces the risk of the firm’s outstanding debt. However, it is unlikely
that this effect explains much of the empirical evidence. While studies of bond returns
in response to equity issues are difficult due to data constraints,Kalay and Shimrat
(1987)find that equity issues on average cause bond prices tofallrather than increase.
Moreover, as indicated above, there is little if any evidence that large debt issues cause
equity prices to rise. In sum, the wealth transfer hypothesis is inconsistent with the
evidence.
4.6. Signaling and the rights offer discount
Heinkel and Schwartz (1986)presents a model in which relatively high-quality unin-
sured rights issuers signal their quality to the market byloweringthe rights offer dis-
counts. They assume that a failed rights offer is costly for all issuers. Suppose there are
two issuer types, “high” and “low”, and let the two firms have the same ex ante market
priceP(before the rights offer announcement). The low type has a greater probability
than the high type of experiencing a stock price reduction over the fixed rights offer
period (say, four weeks) before the rights expire. If the rights subscription priceP 0 is
set close toP, the rights are expected to trade close to zero, and the probability that the
offer will fail (because the stock price drops) is greatest for the low-value type. In the
separating equilibrium considered byHeinkel and Schwartz (1986), the high-value firm
signals its type by reducing the rights offer discount.
Alternatively, one may use a signaling models such as that ofJohn and Williams
(1985)to generate apositiveimpact of a rights offer discount, opposite toHeinkel and
Schwartz (1986). As discussed byHietala and Loyttyniemi (1991)andBigelli (1998),
in some European countries, a rights offer sometimes produces an increase in dividend
yield. For example, if the rights offer does not affect the firm’s dollar dividend per share,
and the rights offer subscription price is set at a discount from the pre-offer stock price,
then the dividend as a percent of the post-offer share price increases as the share price
falls due to the discounted sale of shares. For a given dollar dividend, the increase in
dividend yield is proportional to the discount in the rights offer price. The dividend yield
will increase as long as the dividend per share is reduced by less than the share-split
effect of the rights offer discount. A positive signaling effect of the dividend implication
of a rights offer discount also reduces the expected cost of offering failure, as it increases
the probability that the rights will be in the money at the expiration date.
We are aware of four studies that report evidence on the information content of rights
offer discounts. First, with their sample of U.S. rights offers,Eckbo and Masulis (1992)
regress the offering-day abnormal stock return (which in the U.S. contains the market