The lack of post-SEO consensus among investors makes a stock price increasingly volatile and can result in bad news for shareholders, according to a new study from Florida International University’s College of Business (FIU Business).
But rather than live with volatility, investors can—and should—demand more disclosure from companies, and companies should proactively provide greater clarity about their objectives, researchers say.
A seasoned equity offering (SEO), when a public company issues new shares, can considerably dilute the holdings of existing shareholders because it increases the total amount of outstanding shares. These transactions are often seen as a sign that management believes the company is in financial trouble and needs to sell equity at low prices or that their shares are overvalued.
“A puzzling observation in the SEO market is that leading up to the announcement, there is a gradual decrease in price fluctuations,” said Suchismita Mishra, professor of finance at FIU Business. “However, immediately after the issue, the price of equity changes and the price fluctuates, goes bezerk and there can be a big fluctuation in profits.”
The research, forthcoming in the Journal of Financial Economics, determined that following the SEO, managers don’t have the same incentive to remain transparent about the information shared because they’ve accomplished their objective: securing the required funding.
As a result, Mishra noted, there is increased disparity in opinions about the firm’s future prospects as to how and where the capital from SEO will be used. Added to that is investors’ optimism or pessimism regarding potential growth.
The researchers analyzed data on SEOs conducted by U.S. firms from January 1980
to December 2011 in Thomson Reuters’ Securities Data Corporation (SDC) Platinum database. Among the requirements were that companies be listed on the NYSE, AMEX or Nasdaq exchanges and that these weren’t utilities or financial companies. The final sample examined 4,501 SEO issuances made by 2,630 firms.
The results can make investors savvier and companies more strategic.
“Investors can avoid behavioral biases such as herd mentality and overconfidence, demanding more disclosure about the project the money raised via SEO will be invested in,” said Mishra. “Firms can rethink their overall SEO implementation strategy and voluntarily disclose more details about the transaction during managerial guidance about Earnings per share (EPS) to analysts.”
The paper was co-authored by Mishra with finance professors Qiang Kang, FIU Business; Ann Marie Hibberta, West Virginia University; and Alok Kumar, University of Miami.