Target Leverage and the Costs of Issuing Seasoned Equity
Finance Research Letters, Vol. 7, pp. 39-52, 2010
24 Pages Posted: 19 Jan 2005 Last revised: 13 Mar 2013
Date Written: 2010
In this paper I examine the relation between the direct costs of issuing seasoned equity (SEO gross spreads) and the change in deviation of firms’ leverage ratios from their estimated targets following SEOs. If underwriters have bargaining power vis-a-vis issuing firms in setting SEO fees and if the tradeoff theory of capital structure holds, then SEO fees should be negatively related to the post-SEO change in absolute deviation of firms’ leverage ratios from targets. I find that this relation is indeed negative and economically and statistically significant, especially in cases in which underwriters have relatively high bargaining power, suggesting that one of the important determinants of SEO fees is the change in firms’ absolute deviations from their target leverage as a result of issuing seasoned equity, and that underwriters are able to capture part of the value created by firms moving towards their leverage targets.
Keywords: target leverage, trade-off theory, seasoned equity offerings
JEL Classification: G24, G32
Suggested Citation: Suggested Citation