Corporate Governance and Investor Confidence in Seasoned Equity Offerings

Abstract:     
We investigate how governance affects investor confidence and costs of raising external equity. Using stock price reaction to SEOs as a measure of investor confidence, we document that investors become more worried about non-productive use of SEO proceeds when (1) states pass laws with deterrent effects against hostile takeover attempts, (2) firms raise takeover defenses prior to SEOs, (3) managerial incentives are less aligned with shareholder value, and (4) firms engage in shareholder-value-reducing acquisitions. The economic magnitudes of the impacts of these governance measures are surprisingly large, explaining virtually all the negative investor reaction to SEOs. These findings challenge the notion that the mere act of issuing equity conveys negative signal about the firm. Rather, the governance structure surrounding the equity issuance has an overriding influence on investor confidence in SEOs.

Keywords: Governance, Equity Issuance, Business Combination Statutes, Takeover defenses, Managerial Incentives, Signaling, Adverse Selection Problem

JEL Classifications: G32, G34

Working Paper Series