Ch. 6: Security Offerings 311
Strictly speaking, tests of theMyers and Majluf (1984)predictionAR0 requires
a sample of direct equity sales to the public. As direct sales are rare events, no such
experiment has been reported to date. Existing studies draw from the set of available
flotation methods, which in U.S. studies is predominantly firm commitment offerings,
while rights offerings dominate throughout the rest of the world. The subsequent the-
oretical work represents attempts to refine the single-flotation-method environment of
Myers and Majluf (1984)in various ways, adding predictive power in samples domi-
nated by more complex flotation methods.
Krasker (1986)allows the size of the investment project—and therefore the required
financing amountI—to vary across firms. He derives a separating equilibrium in which
greater amountsIimplies greater adverse selection, soARis more negative the greater
the amount raised in the offering.
Giammarino and Lewis (1988)introduces a simple bargaining game between the
issuer and an uninformed financial intermediary. The purpose is to examine the im-
plications of allowing the purchaser of the issue to reject the offering (which never
happens inMyers and Majluf (1984)). The issuer suggests an offer price that is either
“high” or “low”, and the financier accepts or rejects the offer. In their semi-pooling
equilibrium, the high-value type always suggests a high offer price, while the financier
randomizes between accepting and rejecting the high offer price, but always accepts a
low offer price. The information content of the issue announcement depends on which
issuer type is most eager to finance the project, measured by the ratio of assets in place to
post-issue value. If the low-value type is more eager, it will find a way to avoid being re-
jected too often by the financier. This is accomplished by randomizing between the low
price (which is always accepted by the financier) and the high price. In this equilibrium,
the low-value type ends up being revealed in the separating part of the equilibrium, so
AR<0. Conversely, when the high-value type is relatively more eager to obtain financ-
ing, the equilibrium impliesAR>0. This latter equilibrium does not exist in a setting
such asMyers and Majluf (1984)wherebis constant across issue types, since then the
low-value type will always be the most eager to obtain financing.
Cooney and Kalay (1993)andWu and Wang (2005, 2006a)allow managers to over-
invest (b<0). InCooney and Kalay (1993), it is possible for a firm with overvalued
stock to issue stock to invest in negative NPV projects, while a firm with undervalued
stock may still issue stock to avoid loosing very profitable NPV investment opportuni-
ties. Thus, in their model equity issuance has two effects, a negative signal about current
assets in place and a positive signal about new investment opportunities, where either
effect can dominate. InWu and Wang (2005, 2006a)the overinvestment is introduced
by explicitly assuming that managers enjoy a certain level of private benefits of con-
trol. In both papers, there is ex ante uncertainty about whether or not an issuer will
try to fund a negative NPV project. They show that this type of uncertainty may pro-
duce a positive equilibrium market reaction to some equity issues. The positive reaction
reflects the surprise when firms issue to fund projects with a greater value ofbthan
expected.