Introduction to Corporate Finance

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.