Short Sales Constraint, Information Content, and SEO Pricing

Abstract

This article empirically examines the influence of the SEC’s Rule 105, Regulation M, on informed trading and the information content of stock prices surrounding the offer day of a seasoned equity offering (SEO). The results of this study show that the constraints on short sales imposed by the Rule inhibit informed trading and hamper the incorporation of information into the stock price for offers with private adverse information and without listings on the options market. These constraints contribute to a substantial increase in price uncertainty and a relatively more sensitive response by the market to seller-initiated trading. After controlling for other potential causes of SEO discounts, such as price pressure and rent expropriation, our results show that the decrease in information content of stock prices just before an offer day have a significant impact on the value discount of an SEO. Rule 105’s restrictions on informed trading appear to cause overpricing of those stocks for which traders have access to private adverse information, thus increasing the pressure to sell on the offer day.