Overinvestment and the Operating Performance of SEO Firms

Financial Management, 2010, vol.39, page 249-272

41 Pages Posted: 17 Oct 2007 Last revised: 3 Dec 2014

See all articles by Fangjian Fu

Fangjian Fu

Singapore Management University - Lee Kong Chian School of Business

Date Written: February 16, 2009

Abstract

Prior studies have documented that firms' operating performance deteriorates following seasoned equity offerings (SEOs). This paper proposes and empirically tests the hypothesis that the poor performance is caused by managers' overinvestment. I show that, subsequent to the offering, SEO firms tend to invest more heavily than non-issuing control firms that are in the same industry and have enough financial slack and similar amounts of investment opportunities. More importantly, I find a negative relation between post-issue investment and operating performance, controlling for investment opportunities and pre-issue performance. The evidence supports an overinvestment interpretation as it stands in contrast to the prediction of an optimal investment model, in which firms in anticipation of decreased operating performance should invest less. Consistent with the overinvestment hypothesis, asset productivity decreases and the probability of delisting increases with excess investment. The negative effect of overinvestment is stronger in firms with relatively fewer investment opportunities.

Keywords: Seasoned Equity Offerings, Operating performance, Overinvestment

JEL Classification: G30, G32

Suggested Citation

Fu, Fangjian, Overinvestment and the Operating Performance of SEO Firms (February 16, 2009). Financial Management, 2010, vol.39, page 249-272 , Available at SSRN: https://ssrn.com/abstract=1021715

Fangjian Fu (Contact Author)

Singapore Management University - Lee Kong Chian School of Business ( email )

50 Stamford Road
Singapore, 178899
Singapore

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