Ch. 6: Security Offerings 359
the determinants of flotation costs and how is it impacted by bond seniority, collateral,
affiliated company guarantees, maturity, sinking funds, call protection, and the instru-
ment’s liquidity and interest rate volatility and changes in the issuer’s capital structure
and financial condition?
We reconfirm the empirical fact—first established byMikkelson and Partch (1986)—
that public seasoned equity issues for cash (that is, SEOs) are rare corporate financing
events.Eckbo and Norli (2006)report that for a sample of 6, 000 +IPOs from the period
1980–2005, about half of the IPO firms undertakenopublic follow-on offering over
the remainder of the sample period (regardless of the security type), and only one-
quarter follow on with a SEO. The low issuance activity is relevant for the more general
question of firms’ capital structure choice, and for a pecking order theory in particular.
Fama and French (2005)show that including employee compensation and equity
swaps in mergers and acquisitions in a broader definition of seasoned equity issues leads
to the conclusion that the typical firm issues equity every year. They view this high fre-
quency of equity issues as evidence against theMyers (1984)pecking order. However, it
is questionable whether the type of information asymmetry assumed inMyers and Ma-
jluf (1984)—which motivatesMyers (1984)’s pecking order—is relevant for employee
stock repurchases and option holdings. Also, equity swaps to finance mergers and acqui-
sitions introduce two-sided information asymmetry, which can under some reasonable
conditions place equity at thetopof a (modified) pecking order. Clearly, additional re-
search on the theoretical placement of equity swaps in a pecking order, as well as on the
trade-off between debt and equity issues is required, before we can have confidence in
the ability (or lack thereof) of the pecking order to explain the nature of and motivations
for firms’ issuing behavior.
There is a large empirical literature providing estimates of the market reaction to
security issue announcements, both in the U.S. and internationally. This market reaction
is interesting in part because it shows a significant equity price dilution affect, even
for issuers who hire reputable underwriters to market their shares. This evidence is
broadly consistent with primary issue markets being characterized by adverse selection.
Research extending the basic intuition provided byMyers and Majluf (1984)adverse
selection model has shown that the amount of price dilution also depends on the degree
to which the issuer’s own shareholders participate in the issue (in a rights offer), the
existence of strong investment opportunities as well as on the sequential nature of the
issuer’s flotation method choice. It is also important to recognize that the Myers and
Majluf model assumes strong management alignment of interest with old shareholders,
which may or may not be the case. The various equilibria from these adverse selection
models predict a negative, zero or positive market reaction to SEOs, which points to the
importance of using carefully “controlled experiments” when testing more generalized
theories of issuing behavior, e.g., such as the pecking order.
The literature on announcement effects represents such “controlled experiments” and
has produced several interesting findings. The typical firm commitment underwritten
offering in the U.S. is met with a statistically significant negative market reaction of
close to−2%, which represents a dilution in dollar terms equal to approximately 15%