New Insights into Rights Offerings as Signals of Firm Quality: Evidence from Australia

6 Pages Posted: 2 Nov 2009

See all articles by Balasingham Balachandran

Balasingham Balachandran

La Trobe University - School of Economics and Finance; Financial Research Network (FIRN)

Robert W. Faff

University of Queensland

Michael Theobald

University of Birmingham - Department of Accounting and Finance

Abstract

The main argument of this paper is that managers effectively signal the quality of their company through their choice of rights issue method. Consistent with this argument, the authors summarize the findings of their own research showing that high-quality companies tend to choose full standby rights issues, with the full backing of an underwriter playing a “certifying” role for investors. By contrast, low-quality firms tend to use partial standby issues with large subscription price discounts, while companies of intermediate-quality choose uninsured rights issues. The authors also provide evidence that full standby rights issues are positively correlated with expected shareholder takeup, while both partial standby and uninsured issues have a negative correlation with takeup. Consistent with the above findings, the market response is most positive (or least negative) in the case of non-renounceable, full standby rights issues with relatively low price discounts. The market reaction is most negative for non-renounceable, partial standby issues with high price discounts.Australian companies can choose among three different types of rights offerings: full standby (also known as “fully underwritten”); uninsured (or “non-underwritten”); and partial standby (“partly underwritten”). At the same time, each of these three kinds of rights offerings can be either renounceable or non-renounceable, with the former providing securities that can be sold while in the latter case the rights are forfeited if not exercised.

The main argument of this paper is that managers effectively signal the quality of their company through their choice of rights issue method. Consistent with this argument, the authors summarize the findings of their own research showing that high-quality companies tend to choose full standby rights issues, with the full backing of an underwriter playing a “certifying” role for investors. By contrast, low-quality firms tend to use partial standby issues with large subscription price discounts, while companies of intermediate-quality choose uninsured rights issues. The authors also provide evidence that full standby rights issues are positively correlated with expected shareholder takeup, while both partial standby and uninsured issues have a negative correlation with takeup. Consistent with the above findings, the market response is most positive (or least negative) in the case of non-renounceable, full standby rights issues with relatively low price discounts. The market reaction is most negative for non-renounceable, partial standby issues with high price discounts.

Suggested Citation

Balachandran, Balasingham and Faff, Robert W. and Theobald, Michael F., New Insights into Rights Offerings as Signals of Firm Quality: Evidence from Australia. Journal of Applied Corporate Finance, Vol. 21, Issue 3, pp. 80-85, Summer 2009. Available at SSRN: https://ssrn.com/abstract=1495297 or http://dx.doi.org/10.1111/j.1745-6622.2009.00241.x

Balasingham Balachandran (Contact Author)

La Trobe University - School of Economics and Finance ( email )

La Trobe University
Bundoora, Vic, 3086
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Robert W. Faff

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

Michael F. Theobald

University of Birmingham - Department of Accounting and Finance ( email )

Birmingham B15 2TT
United Kingdom
0121 414 6678 (Fax)

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