Earnings and risk changes surrounding primary stock offers

**••*

HD28 .M414 no.

SI

|MAY

9

1991

EARNINGS

AIJD RISK

CHANGES

SURROUNDING PRIMARY

STOCK OFFERS

Paul M. Healy School of

Management,

M.I.T.

EARNINGS

AND

RISK

CHANGES

SURROUNDING

PRIMARY

STOCK

OFFERS

PaulM.Healy SchoolofManagement,M.I.T.

Krishna G.Palepu HarvardBusinessSchool

January

1989

Forthcoming: Journal ofAccounting Research

We

wish tothank

Andrew

Christie,

Bob

Kaplan, Richard Leftwich. Maureen McNichols, Stewart Myers, Pat O'Brien, Richard Ruback, and the participants of workshops at Carnegie-Mellon University, Columbia University, Cornell University, M.I.T., University of Minnesota, and

NBER

for

comments

on the paper.

We

owe

special thanks toJim Patell,the referee, for his

valuable suggestionswhich significantly improvedthe paper.

We

also thank Paul Asquith and David Mullins for making their sample available for this paper and Eileen Pike for research assistance. The paper has beenfunded by theDivision ofResearch, HarvardBusinessSchool.

ABSTRACT

This paperinvestigates the natureofthe information conveyed byprimary equityoffer

decisions.

The

resultsareas follows. (1)Offerannouncements appeartoconvey information aboutfutureriskchangessince they areaccompanied byincreasesinasset betas,and decreases

in financial leverage, the net effect ofwhich is toincrease equity betas.

On

averagethe

increase in equity betas is consistent with the average stock price reaction to the offer announcement. (2)

The

risk information conveyed by equity offers is firm-specific since other firmsin the offer firms" industries donot experiencesimilarriskandleverage changes. (3) Equity offers do not convey

new

information about offer firms' future earnings levels.

These

results are consistent with

managers

deciding to issue equity and reduce financial

leverage

when

they foreseeanincreaseinvolatilityof their firms'earningsduetoanincreased business risk. Firms' stated reasons for equity offers, and post-offer earnings volatility

supportthisinterpretation. Investors, recognizingthat managers havesuperior information on

their firms' prospects, interpret offer

announcements

accordinglyand revise the offer firms'

1.

INTRODUCTION

Several recent studies, including Asquith and Mullins [1986], Masulis and Korwar

[1986], Mikkleson and Partch [1986], and Schipper and Smith [1986],

document

stock price

declinesat seasonedequityofferannouncements.

One

explanation proposed forthese price

declinesis that managers'equityofferdecisionsconvey

new

informationto investorsonfirms'

prospects.I Our paper examinesthis hypothesisand provides evidenceon the natureofthe

information revealedbyequityoffers by analyzingpost-offerchangesinassetandequitybetas,

financial leverage,unsystematicrisk,earnings levels, andanalysts' earnings forecasts.

We

findthatoursampleofequityofferfirmsexperiencesasignificantincreasein asset betas subsequent to the offers.

The

sample firms also

show

a decrease in their financial

leverage following theoffer. The neteffectofthesechangesis toincrease offer firms'equity

betas.

On

averagethe equitybeta increaseisconsistent with theaveragestockpricereaction to

theofferannouncement.

The

offerfirmsdo not have adecline inearningsfollowingtheoffers

and financialanalystsdo not lowertheirpost-offer earningsforecasts forthesefirms.

Theseresultsindicate thatequityoffersdo convey

new

informationto investors,andthat

the informationisaboutchangesintheriskinessratherthanchangesinthelevel offuturecash

flows.

One

interpretation ofthese findingsis that

managers

decidetoissue equity and reduce

financial leverage

when

they foresee an unexpected increase in their firms' business risk.

Investors, recognizing thai

managers

have superior information on the firms' prospects,

interpret equity offerdecisions accordinglyand revise the offer firms' asset andequitybetas

upward.

hypotheses testedin the paper. The sample anddata collectedfor thetestsare describedin

section3. Section 4examines changesinanalysts'earningsforecasts,aswellasactual earnings

changesfollowingequityoffers. Section 5 presentstestsandresults ofassetand financial risk

changes subsequent to equity offerings. Discussion and interpretation of the results are

presentedinsection6,andsection 7summarizesthe conclusions.

2.

NATURE OF

INFORMATION

CONVEYED

BY

EQUITY

OFFERS

2.1

Review

of Prior

Work

In this section

we

discuss three prominent models ofequity issues to motivate the hypotheses testedin thepaper. The models

assume

thatmanagersactintheinterests of their

shareholders, and arguethat anequityofferannouncementprovides informationto the capital

market only if

managers

are better informed than investors.

The

threemodelsanalyze the

nature of the information revealed by equity offer

announcements

by

making

different

assumptions about

how

the offerproceeds are used - to retireexisting debt, tofinance

new

investments, ortofundshortfallsin operatingcash flows.

When

theproceeds are usedtoretiredebt, equityoffersreveal information toinvestors aboutchangesin firms'capital structure. Donaldson (1961),andDeAngelo and Masulis [1980]

argue that, allowing for taxes and positive costs of financial distress, the optimal capital

structure decision for a firm involves balancing the potential tax benefits from increased

leverage againstfinancialdistresscosts.2 Firmswhichexpect high andstable profitsarelikely

to borrow more becausethey can usethe interest tax shields. Conversely, firms with high

business risk, and hence

more

volatile profits, are likelyto borrow less

because

additional

borrowing increases expectedfinancialdistresscosts morethan theexpectedbenefits. Thus, a

of its future earnings. Masulis [1983] extends this analysis and argues that, if there is

information asymmetry between managers andinvestors regarding thefirm's future prospects,

and managers choosecapitalstructure to maximizeshareholders' wealth, a decisiontochange

leverage indicates to investors a change in managers' expectations.3 Hence, a

leverage-decreasing equity issue

announcement

will indicate that

managers

expect the firm's future

earningsto beeither lower ormorevolatile than previously anticipated.

Ifthe proceedsofequityoffers areusedtofundcapital expenditures,Myers andMajluf

(1984)

show

that offer announcements conveyinformation about thevalueof firms'

assets-in-place. Intheirmodel, aseasonedequityofferingisa claimonthefirm'sassets-in-placeand on

a

new

project.* Managersare

assumed

to haveinformationsuperiorto investors'onthevalueof

thefirm, andtoactintheinterests ofexisting shareholders. Indecidingwhetherto issue equity

andundertake the

new

project,managerstrade-offthe valueofthe

new

projectagainst potential

wealth transfers between existing and

new

stockholders given managers' superior information on whether the firm is over- or undervalued. Myers and Majluf

show

that investorsthen

interpret an equity offering asbad news, since

managers

are morelikely to sell

new

equity

when

they expect the cash flows generated by existing assets to be lower, or riskier than anticipatedbythemarket.

The

third use of equityoffer proceeds is the financing of shortfalls inoperating cash

flows. Miller and

Rock

[1985] examine this situation, assuming the firm's financing and

investment policies are fixed, and

managers

have superior information to investors on the

current period's operating cashflows. Given theidentity between cash sources anduses, an

equity offer is interpreted by investorsas indicating that

managers

have revised

downward

To

conclude, Masulis [1983] and

Myers

and Majluf [1985) predict that offer

announcements

convey information to investors about either the level orriskiness of future

earnings. Miller and Rock's (1985] prediction is more specific, thatthe information is about

the levelof earnings.

Two

empirical studies (Mikkleson and Partch [1986], and Masulis and

Korwar [1986]) attempt to provide evidence on these predictions. Since it is difficult to

observe directly the information revealed by managers

when

they

announce

an equityoffer,

these studies examine the cross-sectional relation between stock price effects at the offer

announcement

andproxies formanagers'private information. Their findings are inconclusive,

possibly

because

the variables used in the cross-sectional analysis are

weak

proxies for managers' private information.s

2.2

Research

Design

and

Hypotheses

Our

research design differs from those of previous empirical studies.

We

examine realized earningsandriskchanges subsequenttoequityofferingsas proxiesforthe information

inferredbythe marketatthetimeoftheoffer announcement. Ifthe price revisionatanoffer

announcement

is based on an unbiased estimate offuture earnings and/or risk changes,

subsequent realizations of these variables provide direct evidence on the nature of the

informationinferredby the market.

The

observedstockpricedeclineattheofferannouncement

therefore can be attributed to either an expected decrease in post-offer earnings, or an

expectedincreasein totalequity risk. Ourempiricaltestsare designedtodistinguishbetween

thesetwoalternatives.

To

test whether the information conveyed by equity offers is about future earnings

levels,

we

examine realizations of offer firms' earnings relative to both their

own

pre-offer

inanalysts*forecasts.Thefollowingfiypotheses are testedfortheoffer firms:

H1A: There is a decrease in earnings subsequent to equity offer announcements, either

relative to pre-offer earnings, or relative to post-offer industry earnings.

H1B: Thereis a

downward

revisioninanalysts' earnings forecastssubsequenttoequityoffer announcements.

Toinvestigatewhetherofferannouncements conveyinformationaboutrisk,

we

usestock returns to examine changes in the riskiness of equity cash flows.

A

change intotal equity variancecan be due toeither afirm-specificchange,orachange in thevariabilityof market

returns. Since the excess returnsthat followequity offer

announcements

are firm-specific,

they cannot be attributedtochanges inmarket variance. Our teststherefore focus onlyon

changes infirm-specific risk,

measured

using the two-parametermarket model:

Re=a+

PeRm

+e (1)

where, Re and

Rm

are the returnsonafirm'sstockandthemarket portfoliorespectively;cz, _Po

(equity beta) are firm-specific parameters; and e isthe

component

of stock returns that is

uncorrelated with the market, andisnormallydistributedwith zero

mean

andvariance a2. The varianceofequityreturns,Var(Rg),canthenbe

decomposed

asfollows:

Var(Re)=P£2Var (Rm)+

a2

(2)

where Var (Rm) isthe variance ofmarket returns,

peando^

aremeasuresofsystematicand

unsystematic equity risk respectively.

The

following hypotheses regarding the firm-specific

H2A: Thereisan increaseinequitybetassubsequenttoequityofferannouncements.

H2B: Thereis an increase inthe residual varianceofstock returnssubsequentto equityoffer announcements.

Increases in equity beta can arise from increases in either asset beta or financial

leverage. It is unlikely that equity offers signal an increase in financial leverage since the

immediate effect of the offer is to reduce a firm's leverage. It is possible, however, that

investorsexpect an equityoffertobe accompaniedbysubsequent borrowing whichwillactually

increase thefirm'sleverageandequitybeta. However,ifmanagers

make

financingdecisionsin

theinterest ofstockholders, expectationsofanincreaseinfinancialleveragecannotexplain the

negative stock price reactionat the offer announcement. Post-offer equity beta increases, if

any, are thereforeexpectedtobeduetoassetbeta increases.

To analyze post-offerasset betas,

we

use theframeworkof

Hamada

[1972]

who

notes

that ifafirm'sdebtisriskless, itsequity betacan bewrittenas:

Pe=Pa{V/E) (3)

where

V

and E are the marketvaluesof assets and equity respectively. Pa represents the

systematic risk of the firm's assets (business risk), and V/E reflects its financial risk.

The

following hypothesis is testedfortheoffer firms:

H3: Anyincreaseinpost-offerequitybetasisduetoanincreaseinasset betasratherthanan increase in financial leverage.

In addition totesting hypotheses H1- H3,

we

perform twofurther tests. First, changes

returnrisk. Second, the statedandactualusesof offerproceedsareexaminedtounderstandthe

reasons

why

firms issueequity.

3.

DATA

Our

equity issue sample comprisesthe industrial firms used by Asquith and Mullins

[1986] in their study of the stock price effects of primary equity offerings.e Asquithand

Mullins examined Moody's IndustrialManualsfor theyears 1963 to1981 toselecttheir initial

sampleofstockofferings. Primaryoffers,forwhich theproceedsare received by the issuing

firm, are included inthe final sample of 128 firms if they

meet

the following requirements:

(1) thefirm is listedon the

ASE

or

NYSE

atthe timeoftheoffering;(2) the offeringis public,

underwrittenand registered with the

SEC;

(3) the offeringis for

common

stock alone; (4) the

firm hasonly oneclass ofvoting stock; and(5) the offering

announcement

is reported in the

Wall Street Journal. Asquith and Mullins reportthat for theirsampletheaverage ratioof offer

proceeds tothepre-offerequityvalue ofthefirm is12.5%.

Sinceourtestsexamine earnings datafor fiveyears beforeandaftera stockissue,

we

use only the first offer if there are multiple offers within five years. This restriction

eliminates 35 of the 128 offers examined byAsquith and Mullins.7

We

collect the following additionaldata for each ofthe 93 sample firms: (1) stockreturn datafordays -850 to +600

relative to the offer

announcement

date (day 0); (2) the annual earnings

announcement

immediately preceding the offer announcement; (3) earnings per share before extraordinary

itemsanddiscontinued operationsforthesix annualearningsannouncementsprior to theoffer

announcement

(years-6to -1) andthe five subsequent annual announcements(years to4);

offerannouncement; (5)intended usesoftheissue's proceeds attheofferannouncennent;(6)

capital expenditures andacquisitions, netchanges in short- and long-term debt, and

common

stock issues net of repurchasesin years -5to 4;and (7)the bookvalue ofdebt (short-term

debt plus long-term debt), andthe marketvaluesofshareholders' equity attheendofyears-3

to 2.

The

stock return data are collectedfrom

CRSP

files, and are used to estimate risk

measures

in year -3 (days -850 to -601), year -2 (days -600 to -351), year -1 (days

-350 to -101), year 1 (days 101 to 350) and year 2 (days 351 to 600) relativeto the offer

year. The earningsannouncementdates, usedto alignthe earningsannouncementsrelative to

the equity offerdates,are obtained from the Walt Street Journal Index. Earnings andother

financial data aretaken from Compustat Industrial and Research Files. Analysts' earnings

forecasts arecollected from Value Line Investment Survey. Intended uses of the offerings'

proceedsaretaken from the Wall Street Journalandofferingprospectuseis.

Table 1 presents thedistributionofthe93 sampleprimary offeringsbyyear. The most

frequent years of offerings are 1980 (23%), 1981 (14%) and 1976 (11%).

The

mean

and

median

risk-adjusted

announcement

returns for the

sample

are -3.1%

and

-2.0% respectively, both significant atthe

1%

level.8

On

average,thisreduction in equityvalue is

approximately

25%

of the magnitude of the offer. Eighty-five per cent of the sample firms have negative

announcement

returns, indicating thatthe

mean

return is not drivenby a few large negative outliers. These results are similar to thoseof earlier studies summarized in

Smith [1986]. The tests reported in thefollowing sections provideevidenceon the natureof

9

4.

INFORMATION

CONVEYED

BY

EQUITY

OFFERS

ON

EARNINGS

CHANGES

4,1

Evidence

on

Time-Series of Actual Earnings

Changes

To

testwhetherequityoffersconveyinformationaboutsubsequentearnings declines,

we

examine earningschangessurrounding theofferannouncements. Annualearn'ngschanges are

computed for sample firms in years -5 to4.9

Changes

inearnings pershareforeachfirmin

theseyears areexpressed asapercentageofitsstockpricetwodaysbeforetheannouncementof

the

common

stockoffering, Pj,sothat resultscan be aggregatedacrossfirms. Thestandardized earningschangeforfirmjinyeart,AEjt,isdefinedas:

AEj, = (Ei,-Ej.t.i)/Pj. t=-5 4 (4)

To

assessthe effectofclusteringof equityoffersovertime,

we

also estimate median earnings changes forthe offer firms' industriesfor these

same

fiscal years. For each offer

firm,standardized earnings changes,as definedabove, are computedforyears-5to4for all

otherfirmsinthe

same

fourdigitSIC code onthe1986 CompustatIndustrialandResearchfiles.

Industry median standardized earnings are estimated for each offer firm and year, where

industry-adjusted standardized earnings changes for a firm are computed as the difference

betweenitsstandardizedearningschanges anditsindustrymedians.

Summary

statisticson standardized earningschanges forthe offering firmsare reported

inPanel

A

ofTable2. Studenttand Wilcoxon Signed

Rank

testsareusedtoassessthestatistical

significance ofthe

mean

andmedianvalues respectively. The

mean

and median standardized earnings changes for the equity issue sample are generally positive and significant at

conventional levels in years -5 to-1. This earnings growth is consistent with the pre-offer

10

evidencethat offering firmshavesystematic earnings declinessubsequenttotheoffers. Infact,

the

mean

earningschangesarepositiveinyears and2,andareatleastas large as the

means

inthepre-offer years. Similarly,the medianearningsgrowth ispositive inyears0, 2and3.

Summary

statistics on industry-adjusted earningschanges are reported in Panel

B

of

Table 2. The

mean

industry-adjusted earningschanges areinsignificant atthe

5%

levelforall

years.

The

test firms have significantly higher (atthe

5%

level or better) median earnings changes than theirindustries inyears0,2and3,inconsistent with the hypothesisthat equity

offersconvey toinvestors the informationthatpost-offerearningswilldecline.io

There is a potential bias from using earnings per share ratherthan total earningsto

compute standardized earningschanges. Ifthecash proceedsofthestock issue are investedin

projects withearnings payoffsbeyond fiveyears,earnings pershare inyears to4 arelikely

todecline, since the increasein the

number

of shares

may

not be offsetby acorresponding increase in earnings.

We

checkthe sensitivity of our results tothis bias by repeating the analysisusing restated earnings persharedataforyears to4based onthe pre-offer

number

ofshares. Theconclusions areunchanged.

4.2

Evidence

on

Revisions in Analysts' Earnings Forecasts

Value Line Investment Survey's quarterly earnings forecast revisions areexamined as

analternative test of thehypothesisthat equity offer

announcements

convey negative earnings

information.i^ Depending onthe fiscal quarterin which the report is issued, the

number

of

quarters for which forecasts are

made

varies from two to six. Value Line revises these forecasts each quarter to incorporate

new

information, including the most recent earnings announcement.

1

1

From

Value Line reports issued immediately before the equityofferannouncement,

we

collectearnings forecastsforquarter {\hequarteroftfieannouncement)andforquarters 1 to

5, depending on data availability. Actual earnings for quarter and revised forecasts for

quarters 1 to 5 are collected from the subsequent Value Line report. ^z Foreach firm, the

standardized forecast error for quarter is the difference between actual and forecasted

earnings, deflatedby the firm's stock pricetwo days prior tothe equity offer announcement;

standardized forecast revisions in quarters1 to5are differences between pre- andpost-offer

earnings forecasts deflatedbythe

same

stockprice.

Summary

statistics on standardized forecast errors for quarter and revisions for

quarters 1 to5 are reported inTable 3. Datafor computingforecast errors are availablefor

71 of thesample firms.13

The

mean

standardized forecasterrorin quarter is

0.21%

andis

significant at lessthan the

1%

level.

The

mean

forecast revisionsin quarters1.2,4and5 are

insignificantatconventional levels.

The

revision forquarter3 is -0.16% and is significant at

less thanthe

1%

level Thus, exceptforquarter3,thereis noevidenceofa

downward

revision

inanalysts' earnings forecasts following the equityoffering.

These

forecast revisions incorporate information not only from equity offer

announcements, but also from the earnings

announcements

for quarter 0. To testwhether

analysts revise earnings forecasts in response to equity offer announcements,

we

regress standardized earnings forecast revisions in each quarter on the equity offer

announcement

return and the standardized forecast errorin quarter 0.

The

coefficient on the equity offer

announcement

return reflects the earnings information provided by the offer, after controlling

for information from the forecasterrorin quarter0. The equityoffer

announcement

coefficient

12

4.3

Summary

Thesefindingsindicate that equity offer firmsdonothavesystematic earnings declines

subsequent to theofferannouncement, relativeeither to prior years' earnings orto the firms'

industryearnings. Further,thereis noevidencethatanalystsrespondtoofferannouncements

byreducingearnings forecastsforquarterssubsequenttotheoffer. Therefore,

we

concludethat

equityofferannouncements donotconveyinformationabout declinesinfutureearnings.

5.

RISK

INFORMATION

CONVEYED

BY

EQUITY

OFFERS

Testsof risk informationconveyedby equityoffersarepresentedin three stages. First,

changes

in the systematic and unsystematic

components

of firm-specific equity risk are

examined. Next, the

components

ofequity systematicrisk,i.e.,asset andfinancialrisks, are

analyzed. Finally, changes incross-sectional earningsvolatilityare investigated.

5.1

Evidence on

Changes

in Equity Beta

and

Residual Return

Variance

As

discussed insection 2,an increase in post-offerfirm-specificstock returnvariance

can be duetoanincreaseineither equitybetaorresidua!returnvariance. To examine changes

in thesecomponents,

we

estimate the equity betaand unsystematicrisk (

Peanda^)

for each

sample firmusing the marketmodel in equation (1). This model is estimated forthreeyears

prior (years -3 to-1) and two years subsequent (years 1 and 2) to the offer announcement

using dailystock returns forthefirmand the

CRSP

equally-weightedmarket portfolio.is

We

alsoevaluatewhethertherearechangesin systematicandunsystematicriskforthe

offer firms' industries. For eachtestfirm, equitybetas and residual variances are computed

13

Industrialand Research files. Industry

means

ofthese variables are then estimatedfor each

offer firmandyear.

To test whether there are changes in offer firms' systematic equity risk,

we

compute changes in theirbetas inyears -2to 2. Foreach offerfirm

we compute

t statistics totest

whetherthe estimated betachanges in these years aresignificantly differentfrom zero.

A

Z

statisticiscomputedforeachyear using thesampledistribution ofestimatedtstatistics.

The

Z

statisticsarecomputedasfollows:

N

Z

=(1/n'N)

I

tj/Aj/(kj-2) (5) j=1

where,

tj =tstatistic forestimatesofthechangein equitybetafor firmjinyears-2to 2;

kj =degreesoffreedomforfirmj;and

N

=

number

offirmsinthesample.

The

t statistic forfirm j is distributed Studentt with variancekj/(kj-2). Under the Central

LimitTheorem, the

sum

ofthe standardized tstatistics is distributed normally with a variance

ofN. The Zstatisticis astandard normalvariate underthe nullhypothesisthatthe changein

betaforyeart (t=-2 to 2) iszero.is WilcoxonSigned

Rank

statisticsare usedtotestwhether

themedianbetachangesaresignificantlydifferentfromzero. The

same

test statistics areused to evaluate whether the

mean

and medianbeta changes for the offer firms' industries are

differentfrom zero in years-2 to2.

To testwhetherthere is asignificant change in market modelresidual variances,an F

14

ofthesestatisticsin eachyearistested usingthe followingChi-Squaredstatistic:

N

X2

=

-21

Inpj (6)

J=1

where Pjis the probability associated with the F statistic for firmj, and

N

is the

number

of

firmsin thesample. Underthenullhypothesisthatthesampledistribution ofthe Fstatisticsis

no different from that expected bychance, this statistic is distributed Chi-Squared with

2N

degreesof freedom.

The same

procedureis usedto testthe significanceof thechanges in

residualvariancesoftheoffer firms' industriesin years-2to2.

Summary

statisticsforestimatesofequitybetasandchangesinbetasoftheofferfirms

are reportedin Panel

A

ofTable4.

The

mean

equitybetaoftheofferfirmsincreases from 1.23

in year -1 to 1.33 in year 1, significant atthe

1%

level. There is asimilarincrease in the

median value ofbeta in these years, also significant at the

1%

level. Thus, consistent with hypothesisH2A,thereis evidencethatthe systematic equityriskoftheofferingfirmsincreases

intheyearsubsequenttotheequityoffer. Thischangeis notduetonon-stationarity ofthebeta

estimates since the

mean

changes in estimates foryears -2and -1 are notsignificant atthe

10%

level.

The

betachangealsodoesnotappeartobe temporarysince the

mean

change in

estimatesfrom year1 to2isnot significant atthe

5%

level. ^^

r\/leanand median equity betasand changes in betasfor theoffer firms'industries are

also reportedin Panel

A

ofTable4. Equityoffer firmsingeneral havelargerbetas thantheir

industries, both in the pre- and post-offer periods.'•s _The

_mean

betachangefortheindustries

15

yearis only 0.01,insignificantat the

10%

level, indicatingthatthe

mean

change is influenced by a few extreme observations.

The

mean

and median

changes

in all other years are

insignificant atthe

10%

level.

These

results indicate thatthe post-offerbeta increases for

theofferfirmscannotbeexplainedentirelybyindustryfactors.

Summary

statistics forestimatesofthemarketmodelresidual variancesforthesample

firms and theirindustries in years -3 to 2 are reported in Panel B of Table 4.

The

mean

(median) residual variance is about

0.05%

(0.04%) in all five years. There is nostatistically

reliable differencebetweenthe sampledistributionofresidualvariance across year. Industry

residualvariances also remaingenerally unchangedduring;hisperiod. The evidencetherefore

indicates that the equity offering firms do not experience

changes

in their unsystematic risk

subsequentto anequityoffer,inconsistent with H2B. Thereisalsono evidencethatthereisan

increase in the unsystematic riskoftheoffer firms' industriesintheseyears.

The economic

significance ofthe magnitudeofthe equity beta increases forthe offer

firms

documented

above can be assessedusing a simple valuationmodel. Assumingthatcash

flows areconstant inperpetuity, the discountrate isdetermined by thetwo-parameter

capitai-asset-pricing model, and the risk-free rate (R() and expected riskpremium (E(Rm) - R() are

constant, the percentagedeclineinstockpricegiven achangeinequitybeta (R|APe) will be as

follows:

-APe(E(R^)

- R,)

RlApe = (7)

R(+Pep(E(Rm)

- Rt)

16

the post-offer equity beta. Between years -1 and 1 the

mean

Pe for our sample of equity

offering firms increases from 1.23 to 1.33. Considera firm with these pre- and post-offer

betas. If the market risk

premium

is

8%,

and the risk-free rate is 5%, expression (7)

impliesthat thisbeta increase leadstoa

5.6%

stockprice decline.i^ Thestockpricedeclineis

predicted to rangefrom

4%

to

7.8%

as the

assumed

risk-free rate variesfrom

10%

to

0%.

Thus, on average, the observed

change

in the betas ofour sample firms is approximately

consistentwiththemagnitudeofthestockpricereactionto equityofferings.20

To

see whetherthe observedriskchanges are related tothe information conveyedto

investorsbythe equityoffer announcement,

we

examine Pearson and

Spearman

correlations betweenthevaluationeffect oftheriskchange,computedforeachfirmusing equation(7),and

the equity offer

announcement

return.21

The

correlationsare not significantly differentfrom

zero atthe

5%

level. These resultscouldbe dueto

measurement

errors,since the valuation

effects of equitybetachanges are

computed

using a simple model,andbetasthemselves are

estimated with error.22

An

alternativeexplanationisthatthebetachangeiscontemporaneous

but unrelated to the equity offer announcement.

To

provide additional evidenceon these

interpretations,

we

examine managers' stated motivations for the offers in section 6of the

paper.

5.2

Changes

in Asset Betas

and

Financial

Leverage

Increases in equity betas can arise from increases in either asset risk or financial

leverage. However,as notedinhypothesis H3, thepost-offerequitybeta increasedocumented

aboveisexpectedtobe duetoan increaseinassetriskandnotanincreaseinfinancialleverage.

17

andfinancialleverage.

Financialleverage, the ratioofafirm'stotalvaluetothevalueofitsequity,iscomputed

foreach samplefirmforyears -3 to2. Thevalueofequityismeasuredusing the marketvalue

of

common

stock plus thebookvalueofpreferred stockattheendoftheyear. Thevalueofthe

firmis the

sum

ofthe value ofequityand thebookvaluesofshort-term andlong-term debt. Assetbetas arecomputedby unlevering equity betas using equation(3)insection2.

We

alsoevaluatewhetherthere arechangesinfinancialleverageandassetriskforthe

offer firms' industries. Foreachtest firmasset betasandleverage arecomputedinyears-3 to

2forother firmsinthe

same

four digitSIC code onthe 1985 StandardandPoor'sCompustat

Industrialand Research Files. Industry

means

ofthese variables are thencomputed foreach

offer firm andyear.

Mean

and medianasset betasand changes inasset betasforthetest firms andtheir

industriesarereportedinPanel

A

ofTable 5foryears-3 to 2.

The

mean

asset betas are stable

in years -3to -1,ranging from 0.73 to0.78. Consistent with hypothesis H3, the

mean

asset

beta for the offer firms increases by

19%

to 0.94 in year 1. This increase is statistically

significant atthe

1%

level,and appearstobe permanentsince the

mean

betaforyear 2isalso

0.94.

The

mean

and median asset betas for the offer firms are similar to those for their

industriesin years -3 to-1. The increase inasset betas for theoffer firms inyear 1 is not

matched by the other firms in their industries. While there is an increase in industry asset

18

Mean

and medianfinancialleverageandchangeinleveragefortheequityoffer firmsand

their industries are presented in Panel B of Table 5 for years -3 to 2. There are

some

differences between the

mean

and median results, due a few extreme observations. The

followingdiscussion focuseson medians, which

we

considerto be more representativeofthe

samplepatterns. The medianleveragechangesfortheoffer firmsare not significantly different

from zeroinyears-2and-1 atthe

5%

level. Inyear 1,themedianleverageoftheoffer firms decreasesfrom 1.50to 1.36, significant atthe

1%

level. Thus, consistent with H3. thereis no evidencethatthe increaseinequitybetainyear1 can beattributed toanincreaseintest firms'

financial leverage, in year 2 the median leverage of the offer firms increases to 1.41, still

lower than the pre-offer level.

The

decrease in the offer firms' leverage in year 1 is not

matched by their industries.

The

median industry leverage remains about 1.55 during the

years-3 to2andthemedian changesinyears-2 to2 areinsignificant atthe

10%

level.23

5.3

Evidence

on

Post-Offer Earnings Volatility

Tocorroborate theincreaseinassetbetasdocumentedabove,

we

examinethevolatilityof

standardized earnings

changes

(asdefined in equation (4) in section 4.1) surrounding the

equityofferannouncements. Since

we

examinearelativelyrecentsampleofequityoffers,the

number

of time-series observations per firm is limited. Therefore,

we

use cross-sectional rather than time-series data.24 Cross-sectional variances and interquartile ranges for the

standardized variables are

computed

in years-5 to4 and an Ftestis usedto evaluate the

significanceofyear-to-yearchangesin variances. The resultsare reportedinTable6.

Thevariancesandinterquartilerangessubsequenttothe offerare generallylargerthan

the pre-offervalues. The variance,which is

0.07%

inyear-1, increases threefold to

0.20%

19

indicatesthat thevariancesin years to 5 aresignificantlygreater than the varianceinyear

-1 atthe

1%

level. Further, theearnings variance in each of the post-offeryears is greater

than the

maximum

pre-offer variance (in year -4).

The

findings from interquartile ranges are consistent with the variance results,suggestingthattheabove resultsare notduetoa few

extremeobservations.

The

increasedearningsvolatilitycorroborates the increasein assetand

equitybetasdocumentedabove.

To

evaluate whetherthis increase in cross-sectional earningsvolatility is experienced

by other firms in the

same

industry,

we

examine the cross-sectional variance of industry median earningspatterns. Foreachtest firm,earningschanges are estimated forotherfirms

thathavethe

same

fourdigitSICcodeonthe1986 Standard andPoor'sCompustatIndustrialand Research Files.

The

earningschangesforeach comparisonfirmare standardizedbyitsstock

price twodays prior tothe test firm's offer

announcement

and industrymedian standardized

earningschangesareconstructedforyears-5 to 4.

Estimates of the cross-sectional variance and interquartile range of standardized

earnings

changes

for theindustry medians in years surrounding testfirms' equity offers are

reportedinPanelBofTable6. Thereis nosignificant increasein thecross-sectional variance

ofindustry

median

earnings in years to 4.

The

post-offer increase in earnings volatility

experienced by the equity offeringfirms is therefore notdue to an industry-wide increase in

earnings volatility.

5.4

Summary

Results of the risktestsreportedinthis section aresummarizedin Figure1, and

show

20

leveragesubsequentto equityoffers. The neteffect ofthesechangesisto increase post-offer

equitybetas. The changesinasset betas, equity betas,andfinancial leverageof the offer firms

are not matched byother firms in their industries. The average increase in equity betas is

consistent with the magnitude ofthe average stock pricedecline atthe offer announcement.

Increases in the cross-sectional volatility of earnings changes subsequent to the offering

corroborate the findingson assetandequitybetas. Thesefindings indicate thatprimary equity

offersconveyinformationtoinvestorson changesin offer firms*businessrisk.

6.

DISCUSSION

The

increase in assetrisk and decreasein financial leverage

documented

above are

consistent with the implications of the capital structure models of Donaldson (1961), and

DeAngelo and Masulis [1980].

They

predictthat capitalstructuredecisions reflectatrade-off

between costsof financial distressandthe interesttax shieldsfromdebt. [Managerstherefore

are likelyto issue

common

stock toreduce theirfirm's financialleverage

when

they perceive

thattherehas been anincreaseintheprobability of financial distress,duetoanincreasein the

firm'sbusiness risk. Managers' decisions to issue

new

equity therefore convey information

abouttheir firms'assetriskincreaseandleveragedecreasetothemarket.25

To

validate this interpretation,

we

examine the stated and actual uses of the offer

proceeds. Thestatedusesofequityoffer proceeds, reportedinthe Wall Street Journalandthe

offer prospectuses, indicatethat a majorityoffirms intendto usethe proceedstoretiredebt.

Fifty-sixpercentofthesample state thatthe primaryuseofthefundsgenerated bythe offeris

to retire debt (48 firms) orto increase the equity base(four firms). In contrast, only

27%

of

the samplefirms state thatthe funds are tobe used primarily tofinance

new

capital projects, and

8%

of the firms report that the intended uses are for working capital (two firms) or

21

general business purposes (five firms).26

The

remaining

9%

of the samplefirms do not disclosetheintended usesofthefunds.27

Several sample firmsexplicitly mention that the proposed equity offeringis partofa

planto reduce leverage. Forexample, Gould Inc.statesin itsannualreportforthe offer year,

that:

...weare placing specialemphasisthisyearonstrengthening ourbalancesheet.

We

plantoreducetheleveloftotaldebttocapitalizationfromthe current39.7% to below the

34%

level. ...We (also) just filed with the

SEC

a registration statement to sell one million shares of

common

stock. Dependent on market conditions,

we

will probablyproceed with this plan in late Septemberor early

October. Proceeds from the proposed financing will be used to increase the company's equitybasethrough the retirementof

medium

term bankloansand short-term debt. (Chairman's letter to shareholders. Annual Report for the period ending June30, 1976).

Value Line analysts also discuss the implicationsofequityoffers forthe samplefirms.

The

most frequently mentioned effect is the reduction in leverage and increase in financial

flexibility. Forexample,theValue Line reporton Tenneco, Inc.subsequenttothe equityoffer

announcementstatesthat:

Tenneco

financed with equity this year.

The

company

recently completed an

offering of3million

common

shares. These wereissuedintheplaceofbondsto

keepthedebtratiounderthe

60%

ceiling. ...theproceedswillbe usedtoretire

shortterm debt (Value Line Report,

May

1,1970).

Evidence on actual uses of the offer proceeds is consistent with managers' stated

intentions. Figure 2reportssamplemedians ofnetdebt issues, net equity issue proceeds,and

capital expendituresfortheoffering firms in years surrounding theoffers. Foreachfirmthese

variables are standardized byitsyear-endtotalassets. Netproceedsofequityissues(thevalue

ofissues less treasury stock acquisitions)are closetozero inyears-5to-1 and 1 to4.28 in

contrast,themedian proceedsfrom equity issues asa percentofassetsinyear is6.3%. Net

2 2

year-5to

5%

in year-1. In year there is a sharp decline in theoffering firms" borrowing,

themagnitudeofwhich iscomparabletotheincrease infunds from equity issues,indicating that

samplefirmsswitch fromdebttoequity financing in thisyear. Subsequentto theequityoffer,

netannual borrowingis stable atabout

2%

of assets.29 Thereis no evidenceofachangein

capitalexpenditures in the equityofferyear.

7.

SUMMARY

Thispaper investigates the nature oftheinformation conveyed byprimary equity offer

announcements.

We

findthat: (1) Offerannouncements convey information aboutfuture risk changes since they areaccompanied byincreasesin asset betas,and decreases infinancial

leverage, the neteffectofwhich istoincrease equitybetas.

On

averagetheincreaseinequity

betasisconsistent with theaveragestockprice reaction totheofferannouncement.

(2)

The

risk information conveyed by equity offers is firm-specific since other firms in the

offer firms' industriesdo not experience similar risk and leverage changes. (3) Equityoffer

announcements donotconvey

new

informationaboutoffer firms'futureearningslevels.

Theseresultsindicate thatmanagersdecidetoissue equityand reducefinancialleverage

when

they foresee an increase in volatility of their firms' earnings

due

to an increase in

business risk.

The

firms' stated reasons for equity offers and their post-offer earnings

volatility support this interpretation. Investors, recognizing that

managers

have superior

information on their firms' prospects, interpret offer

announcements

accordingly and revise

theoffer firms'assetandequitybetasupward,resulting in a negative marketreaction.

The

findings of this paper have implications for future theoretical work on the

23

single model to analyzecapital structure anddividend decisionsandpredict thatbothconvey

information on futureearningslevels. While thefindings ofOferandSiegel[1987],and Healy

and Palepu [1988] confirm the predictionthatdividend decisions convey informationon future

earningslevels, thispaperfindsthatthe informationconveyed by equityoffersisaboutfuture

risk. Thissuggeststhatseparatemodelsarenecessarytoanalyze dividendandcapitalstructure

decisions.

The

modelsof Donaldson (1961), DeAngelo and Masulis [1980], and Myers and

fVlajluf[1984] are broadly consistent withthis paper'sfindings. However, ourresultssuggest

that there is scopefor refining these models by explicitly considering the role of systematic

24

REFERENCES

Asquith, Paul and DavidMullins,Equity issuesandoffering dilution,Journalof Financial

Economics

(1986): 61-89.

Brealey, R.andS. Myers, Principlesofcorporate finance, McGraw-Hill.

New

York, 1984. DeAngelo, H.and R. Masulis, Optimalcapitalstructure undercorporate andpersonaltaxation,

Journalof Financial Economics (1980): 3-29.

Donaldson, Gordon, Corporate debtcapacity, Boston. DivisionofResearch, Harvard Business School, 1961.

Hamada,

Robert S..

The

effect the firm'scapitalstructure on the systematicriskof

common

stocks. Journal of Finance (1972):13-31.

Heaiy. Paul M.

and

Krishna G. Palepu, Earnings information

conveyed

by dividend

initiations andomissions, Journal of Financial Economics (1988): 149-175.

Ibbotson,R.G. and R.A. Sinquefield. Stocks, bonds,billsandinflation:

The

pastandthefuture,

Financial Analysts ResearchFoundation,Charlottesville, Virginia, 1982.

Jain,

Prem

C.

Equityissuesand changesinexpectationsofearningsbyfinancial analysts.

Unpublishedpaper,Wharton School, Universityof Pennsylvania, 1988.

Jensen, M..Agencycostsoffreecashflow,corporate financeandtakeovers. American Economic

Review

(1986): 323-329.

Masulis, Ronald and

Ashok

Korwar,

Seasoned

equity offerings:

An

empirical investigation.

Journal ofFinancial

Economics

(1986): 91-188.

Masulis, Ronald, 1983,

The

impactof capitalstructurechange onfirmvalue:

Some

estimates. Journal ofFinance (1983): 107-126.

Mikkleson,

Wayne,

and

Megan

Partch, Valuation effects ofsecurity offeringsand the issuance process. Journal of Financial Economics (1986): 31-60.

Miller. Merton and Kevin Rock. Dividend policy under asymmetric information, Jpijrnglpf

Finance

(1985): 1031-1051.

Myers.Stewart and Nicholas Majluf.Corporate financing andinvestment decisions

when

firms have information that investors do nothave. Journal of Financial Economics (1984):

187-221

.

Offer, A. andD. Siegel,Testsof signalling models using expectations data:

An

application to

25

Schipper, Katherineand AbbieSmith,

A

comparison ofequitycarveouts and seasoned equity offerings: Sfiare price effects and corporate restructuring, Journal of Financial

Economics

(1986): 153-186.

Schioies, Myron, Market for securities: Substitution versus price pressure and the effects of

information on share prices. Journal of Business (1972): 179-211.

Smith, Clifford, Jr., Investment banking and the capital acquisition process. Journal of

26

FOOTNOTES

1. Two other explanations have also been proposed. Jensen (1986) suggests an agency cost

explanationforthenegative nnarket reaction toequityofferannouncements. Assumingthat thereisa

conflict ofinterestbetween managersandstockholders, hearguesthat thenegativemarketreactionis

due toinvestors' expectationsthat the increasedfreecash flowsfrom anequity issuewillbe used by managers for value-reducing activities. This paper assumes that managers act in the interest of

shareholders andthereforedoesnottestthis explanation. Another viewisthatsellingequitycauses a

firm's stock price to fall because thedemand curve for its shares is downward sloping. However,

theoristsrejectthisview by arguing that theprice ofasecurity isdetermined solelyby the expected

level andriskinessofitscashflow.

2. DeAngeloand Masulispoint out thatintheabsenceoffinancialdistress costs, capital structure is

determined by a trade-offbetween interesttax shieldsand other tax shields, such asdepreciationand investment tax credit.

3. Masulis (1983) providesevidence on thishypothesisfora sampleofexchangeoffers.

4. WhileMyers andMajluf'smodelassumesthattheproceeds are usedforanewinvestmentproject, theiranalysis isalsoapplicable todebtretirement, provided thishasa positive netpresentvaluefor

shareholders.

5. Mikkleson and Partch (1986) use the following proxies: (1) the net amount of

new

financing

provided bytheoffer, (2) thesizeofthe offering, and (3) the stated reasonsfor theoffering. They conclude thattheir resultsdo notsupport thehypothesisthatstockissuesconvey informationabout a

firm's earnings prospects, assets-in-place or investment opportunities. Masulis and Korwar (1986)

examine the relation between equity offer announcement returnsand (1) the proportionalchange in

outstanding shares of

common

stock, (2) the offering-induced leverage change, (3) the pre-offer-announcement price run-up, and (4) the pre-offer-announcement stock return variance. The only variable foundtobe relatedtothe offerannouncementreturn isthepre-offerpricerun-up.

6. Asquith andMullinsalsoexamine secondaryequityoffers. This paper focuses on primaryofferings

since itis possiblethat the natureof informationprovidedby thetwoisdifferent. Toinvestigatethis

issue, wealsoanalyze earningsand riskinformation conveyed by secondaryoffers. Results ofthese

testsare discussedbrieflyin footnote 25.

7. This restriction eliminates observations for repeat offerfirms. If there isa systematic difference

between these observations andthose inthesample, our resultsmaynotbe generalizedto allequity

offers. There is nocurrenttheorythat distinguishesbetween repeatandinfrequent equityofferors.

8. Risk-adjusted announcement returns aremarket model predictionerrors for one day priorto and

thedayoftheWall StreetJournalreportonthe offering. Themarket model parametersare estimated using returnsforthe firmand the

CRSP

equal-weighted marketportfolioindays 101 to350.

9. Since equity offers occur throughout the fiscal year, the fiscalyear earnings in the offer year

includeearnings forsome quartersannounced beforetheofferand somequartersafter theoffer. To

separate earnings before and after the equity issue announcement, the earnings tests also are

performed using annual earnings constructed from quarterly datacollected from CompustatQuarterly

27

subsequent to the offer (quarters 1 to 4); year -1 earnings areconstructed from the fourquarterly earnings priortothe offerdate (quarters-4 to-1). Similarly, earningsfor years-6 to-2 and 1 to4 areconstructed usingearnings from quarters -24 to-5, and 5to20 respectively. The results using earnings defined thiswayare not materially differentfromthose reported in thepaper forfiscal year

earnings.

10.

We

examinethecross-sectionalrelationbetween standardized earnings changesin years to4,

andthe equity offerannouncementreturns. Thecorrelationsare insignificantat the

10%

level in all

years.

11. Another source of earningsforecasts, commonly used by accounting researchers,is the IBES database.

We

donotusethissourcebecauseIBESforecasts are not availableformanyofoursample

years. Jain (1988)analyzes revisionsinIBES forecastsforarecentsampleofequityoffers.

12.

We

findthattheValueLinereportsdiscuss the offerand itsfinancial implicationsforeachofthe

sample firms, indicating that their post-offerforecasts are likely to incorporate information from the equity offers.

13. To ensure thatall available forecasts are included inthe analysis, reports are collecteddirectly

fromthe ValueLine library.Value Line reports are unavailable for22 sample firms. The numberof

quarters with forecastsavailable variesfrom firmto firm. Seventy and60 observations are available inquarters1 and 2respectively; the numberofobservationsdeclinesmarkedlyinsubsequentquarters.

Thus,the resultsare notdirectlycomparable across quarters.

14. Thecoefficient ofthequarter forecast errorisinsignificantatthe

10%

levelin regressionsfor

all quarters other than quarter 3. The coefficient for that quarter, which is significant at the

5%

level,suggests thatthe negative forecast revision inthatquarterreflects information conveyed by the forecasterror in quarter0, and notequityoffer information.

15. The tests have been replicated using value-weighted market returnsand also Scholes-Williams

estimates of betas. Ourconclusions areunchanged.

16. Thetest is based onthesample distributionofthe parameterdifferences. Itassumesthat the

parameter differencesareindependent acrossfirms inthesample. Thereported teststatisticswill be

overstated ifthisassumption isviolated.

17. The

mean

estimateofa fortheequityoffer firms inyear-1 is 0.0004 and statisticallysignificant atthe

1%

level. This finding is consistent withthe results of Asquith and Mullins, who report that equity offering firms experience significant positiveexcess returns prior to the offer announcement. The meanestimatesofa for theotheryears are not significantlydifferentfrom zero atthe

5%

level.

Thesepositive pre-offerexcess returns maycausetheestimate ofoffering firms'equitybetasinyear

-1 tobe biased downward. However,thisbias,ifany,doesnotappeartoexplain the reportedincrease inbetainyear 1. Thisisbecausethemeanequitybetainyear1 is alsosignificantlylarger(atthe

5%

level) than thevalues in years-3 and -2, even though estimatesofa are notsignificant (at the

5%

level) in theseyears. The Z statisticforthemean increase in 3is3.14foryears 1 and-2. and1.85

foryears 1 and -3.

18.

We

perform appropriatestatisticaltests, not reportedin Table 5, toverify this statement. 19. Ibbotson and Sinquefield (1982) report that the average annual risk premium (the return on

28

common

stocks minus thereturn on treasury bills) during the period 1926 to 1981 was8.3%. The average annua!return ontreasury billsduring thisperiodwas3.1%.

20.

We

alsoestimate the valuationeffectof riskchangesforeach ofthesample firmsseparately using theabovemodel.Themeanand medianimplied pricedeclines arecomparabletothose reported above.

21. Thevaluationeffect oftherisk change iscomputed using firmchanges in equitybetabetween

years 1 and -1, a market risk premium of8%, and three alternative risk-free rate assumptions,0%,

5%

and 10%. Equityoffer announcement returnsare risk-adjusted returnsforthedaybeforeandthe

day of the Wall Street Journal report of the event.

Two

measures of risk-adjusted returns are

computed, using pre- and post-offer market model parameters. The results are similar for these

different variable definitions.

22. To examinetheeffectofusing thesimple valuationmodel,were-estimate the correlations using 8

changes themselvesratherthantheirvaluationeffects. Theresults remaininsignificant.

23. The mean results donot changethe primary conclusionofthe leverage analysis, namely,that there is a significant decline in offer firms' leverage in year1. However, in contrastto the median

results, mean results indicate aleverage decrease inyear -1 and no increase inyear 2. Foroffer firms' industries,the onlydifference in the

mean

and median resultisin year 1. While the median

leveragechangeinthatyearisinsignificant,themean leveragechangeispositiveandsignificant atthe

5%

level.

24. Thisprocedureassumesthat the distributionofstandardized earningschanges isthesameforall

sample firms, and does not discriminate between changes in firm-specific and market-wide risk

changes. Becauseoftheselimitationsweview thesetestsas secondarytothereturn-basedtests.

25. Asquith andMullins (1986)find thatsecondaryequity offerannouncements, which donotchange

firms' capital structures, also produce a negative market reaction similar to that for primary

offerings. Since the capital structure interpretation of primary equity offers cannot be applied to

secondaryoffers,

we

expect theinformationconveyed bythetwo eventstobedifferent. Totest this,

we

briefly examine risk and earnings changes surrounding85 registered secondary offers from the

period 1963-81. The sample comprises all secondary offers examined byAsquith and Mullinswhich

satisfy the same criteria usedto selectprimary offers in our study. In contrast to the findings for

primary offers,

we

find thatsecondaryofferfirms have lowerearnings, butno changesin riskin the post-offerperiod, confirming thatthe information conveyed by these two events isdifferent.

26. Twenty-oneof thefirms thatstate theyplan to usethe proceedsfor newcapital expenditures indicate that the newprojectsare expansions ofcurrentbusinesses, whereas only four firms indicate thatthey plantouse theproceedsforunrelatedbusinessexpenditures.

27.

We

separately examinepost-offerassetbeta changes forfirmsthat statethatthey intendusing theproceedstofinancenewinvestments, and toretiredebt. The post-offerbetachanges forthe two groupsare not significantly differentat the

10%

level.

28. Thesampleselectionrequires firmstohave noequity offersinyears-5to-1.

29. Industrynetborrowing ranges fromone totwo percentofassetsin years-5to4 andthereis no sharpdecline inyear0. Netequity offers forthesamplefirms'industries arezero throughouttheten

Table 1

Distribution of primary stock offerings by year in the period

1966

to 1981 for 93

sample

firms*

Number

Year

of firms

1966

2

1967

1

1968

3

1969

3

1970

7

1971

8

1972

3

1973

1

1974

1

1975

8

1976

10

1977

1

1978

5

1979

6

1980

21

1981

13

Percent of

Summary

statistics on changes

m

earnings per share as a percentage of initial

equity price for years surrounding primary equity offer announcements^-''

Period relative to equity offer

Number

of firms Meanc First quartile f^edianc Third quartile

Panel A:

Raw

earningschanges Year -5

Table 3

Summary

statistics on analysts' earnings forecast errors and forecast revisions as a percentage ofinitial equity price

for quarters following primary equity offer announcements^

Period relative

Number

to equity offer of firms Meanb

First

quartile Median^

Third quartile

Analysts' forecast error:

Quarter 71 0.21

%c

-0.03% 0.1

0%c

0.41%

Analysts' forecast revisions:

Summary

statistics on market model risk parameters for firms announcing primary equity offerings and their industries in years surrounding the offers^.**

Year relative to offer announcement

-2 -1 1

Summary statistics on asset betas andfinancialleverage (or (irms announcing

primaryequity offeringsand their industries

m

yearssurrounding the otfers^b

Year relative to offerannouncement

-2 -1 1

Table 6

Summary

statistics on cross-sectional variability of changes in

earnings per share as a percentageof initial equity price forfirms announcing primary equity offerings in years surrounding the offers^

Period relative to equity offer

Number

of observations Estimated variance Interquartile range

PanelA:

Raw

earnings

Year 91

92

92

92

92

93

93

93

91

88

0.06«/

Figure 1

Summary

ofmedian changesinasset betas,financialleverage,andequity betasfor

equityoffer firmsandtfieirindustries in years surroundingofferannouncements

PanelA: Equityoffer firms

cn>» f3 O O) e -S 3 u « ₃ 3 »_ cr o o * C U) 2 nj qj {8 «

a

<» « <D 2 9-10 -CCO

_

>—CDJ3 to r-T3