This thesis examines the relationship between managerial manipulations and security valuations in the seasoned equity offerings (SEO) process. The thesis comprises three essays based on separate, but related empirical investigations that collectively enlighten our understanding of the role of managerial opportunism in the context of corporate financing policy.
Chapter 2 presents the first empirical essay. It examines the motivations for SEOs and the decomposition strategy that breaks the book-to-market ratio into misvaluation and growth components. In logit-based tests, we find strong support for the misvaluation explanation, which predict that firms issue when equities are overvalued. However, the growth component runs counter to conventional wisdom as a proxy for investment opportunities and obscures a more complicated relationship between the accounting for operating and financing activities (leverage). Given a low book-to-value ratio, two groups of firms are both likely to conduct an SEO: one with low operating growth and positive leverage, whereas another group with high operating growth and negative leverage. Apart from market timing, the former is also motivated from a demand for liquidity whereas the latter is consistent with an investment-based explanation. Finally, we document evidence that issuers with low growth opportunities and/or high overvaluation are more likely to issue combined or pure secondary shares rather than primary shares.
Chapter 3 presents the second empirical essay. In essence, it examines whether firms use classification shifting to raise reported core earnings around seasoned equity offerings (SEOs). As such, this study provides the first known evidence of the manipulation of core earnings in the equity issuance context. To the extent that investors focus solely on non-GAAP 'core' earnings, managers have incentive to inflate core earnings rather than bottom-line return on assets (which remains unaffected) through earnings management. If successful, this leads to investors misinterpreting the issue prospects and subsequently overvaluing new issues. Using a core earnings expectations model, which builds on the approach of McVay (2006) and extended by Fan, Barua, Cready, and Thomas (2010) with quarterly data, we provide evidence supportive of manipulation in the form of a positive association between income-decreasing special items and unexpected core earnings in the fourth quarter. We also find that issuers’ choices to use classification shifting or accrual earnings management strategies depends on auditor’ characteristics, flexibility and detection probability. Finally, we compare the effect of the two means of manipulation strategies and provide evidence that classification shifting is less likely than earnings management to be associated with post-issue performance declines.
Chapter 4 presents the third empirical essay. It investigates the management of liquidity around SEOs and also the relation between such liquidity management and long-run operating and market performance. We classify issuers as ‘credit-constrained’ (‘cash-squeezed’) having net debt-to-assets lower (higher) than the median non-issuers. ‘Credit-constrained’ firms experience significant increases in cash following new equity issues, whereas for ‘Cash-squeezed’ firms, there is a significant decline in long-term debt. We interpret these results to imply that offering proceeds are at least partly being used for liquidity motives. We also report new evidence that issuers who aggressively manage liquidity prior to the offering have lower post-issue operating profit. However, the relation does not hold for market performance because investors observing the liquidity information will immediately discount stock value at the time of the offering. Rather, post-issue market underperformance can be attributed to investors’ downward revisions related to the transitory nature of investment opportunities from the SEOs.