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Option Introduction and Secondary Equity Offerings

Minggu, 22 Mei 2011 | No Comments | Labels : ,

Option Introduction and Secondary
Equity Offerings

Kishore Tandon, Susana Yu, and Gwendolyn Webb

Substantial empirical and theoretical evidence indicates that trading in options is associated with increased market efficiency- especially with respect to the incorporation of negative information in stock prices (Figlewski and Webb. 1993). This paper focuses on the potential role of option
trading on the price effects of secondary equity offerings (SEOs). In doing so, we emphasize an important area of research in corporate finance that is affected by option trading, but that may not he familiar to researchers whose work is primarily in the areas of derivatives and derivatives
Announcements of seasoned equity offers are associated with negative abnormal stock retums. This empirical tendency was first predicted in the adverse selection model of Myers and Majluf (1984). Two fundamental asstimptions in their model are that the objective of the firm's managers is to maximize the value of the firm for its current shareholders, and that the firm's managers have better infonnation than outsiders about the value of the firm's assets. If the
managers know that the stock is currently undervalued in the marketplace., they will not be willing to issue new shares. If, however, they believe that the stock is overvalued, then
they will offer new shares. Outside investors are aware of these adverse incentives, and, therefore, interpret the announcement of a new offer as negative information. The expected negative response to an SEO announcement is strongly supported in a substantial body of empirical evidence.

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