Understanding Stock Price Behavior Around the Time of Equity Issues
ASYMMETRIC INFORMATION, CORPORATE FINANCE, AND INVESTMENT, R. Glenn Hubbard, ed., University of Chicago Press, 1990
40 Pages Posted: 21 Oct 2011
Date Written: September 1989
The link between the real and financial decisions of firms has been studied for many years, yet it remains poorly understood. Neoclassical investment theories such as Tobin's q posit a direct, simple link between the market's valuation of the firm and investment decisions: firms invest when the market value of an investment exceeds the cost of the investment. For a variety of reasons - agency conflicts between management and security holders, conflicts among security holders, and asymmetric information between management and security holders - the relation between real and financial decisions may be quite complex.
In this paper we study seasoned equity issues as one piece of the corporate financing and investment puzzle. We expect equity issues to be particularly revealing about the role of asymmetric information in financing decisions. First, to the extent that there is asymmetric information between management and outside security holders, the asymmetry should be of greatest concern to potential buyers of common stock since stock is the residual claim on the firm. Second, it is well documented that stocks exhibit large abnormal returns during the period surrounding an equity issue. This suggests that equity issues do in fact reveal valuable information to the market. It is therefore natural to consider whether the price behavior of an equity-issuing firm sheds light on the importance of asymmetric information in the investment process.
Keywords: equity issues, adverse selection, asymmetric information
JEL Classification: G32, G14
Suggested Citation: Suggested Citation