290 B.E. Eckbo et al.
volatility falls, then bid–ask spreads will also fall since the expected costs of market
making decline. The SEO announcement per se can also lower the asymmetric infor-
mation about the firm’s stock price borne by market makers, which would cause bid–ask
spreads to drop further.
Amihud and Mendelson (1986)develop a valuation model of security pricing that
assumes that investors have a positive preference for liquidity measured by percentage
bid–ask spread. They derive a model of security pricing where the expected return is
a positive and concave function of bid–ask spread.Amihud and Mendelson (1988)ex-
tend the implications of the model and present evidence that liquidity is an important
determinant of security value. They argue that managers seeking to maximize current
stockholder wealth should take market liquidity into account when making corporate
financing decisions. Thus, in deciding whether to make an SEO and in choosing the
flotation method, liquidity implications need to be taken into account. A further impli-
cation is that the negative adverse selection effect of the offer announcement can be
partially offset by the positive liquidity effect.
Lease, Masulis, and Page (1991)explore the market microstructure effects of firm
commitment SEOs for NYSE and AMEX listed firms. They document that share trad-
ing volume rises substantially and that price volatility falls subsequent after the SEO.
Not surprisingly, both dollar bid–ask spreads and percentage spreads fall significantly
after the seasoned public offering, consistent with inventory cost and adverse selec-
tion cost models of bid–ask spread determination. They also report that trading volume
and price volatility fall between the announcement and the offer dates, while bid–
ask spreads drop, but not to the level observed subsequent to the public offer. This
is suggestive of a modest increase in liquidity following the SEO announcement and
a significant improvement after the SEO. Not withstanding the improvement in stock
liquidity,Altinkilic and Hansen (2006)report that on average issuer stocks experience
an abnormal negative return of 2.6 percent over the week prior to the SEO. They also
find that this effect cannot be explained alone by a short term price reversal effect in the
immediate post-SEO period and suggest that this is due to a negative information effect
related to the underwriting process.
Tripathy and Rao (1992)examine the market microstructure effects of SEOs for
NASDAQ listed firms. They split their sample into large and small capitalization stocks
and that larger stocks have increases in bid–ask spread over a 60 day period prior to an
SEO announcement, which is followed by decreases in spread over the next 43 days.
In contrast, small stocks experience increases in spread from 80 days prior to the an-
nouncement through 20 days after the announcement. Focusing on the public offering
date, they find that the bid–ask spreads of large stocks decrease over the 20 days prior
to the offering and decrease even more over the 20 days following the offer. Spreads of
small stocks increase over the 20 days prior to the offering, but then decrease beginning
just before the offering through 20 days after.
Masulis and Shivakumar (2002)separately investigates the speed of price reactions
measured in 15 minute intervals to SEO announcements by NYSE/Amex and Nasdaq
listed stocks. They report that Nasdaq listed stocks react more quickly to these an-