Seasoned Equity Offering ( SEO ) is embedded in the field of Corporate Financing surveies. Agca, Senay and Mozumdar ( 2005 ) concluded from their survey that the chief beginnings of corporate finance are Retained Net incomes ( 1st ) , Debt ( 2nd ) and Equity ( 3rd ) . During the last fiscal crisis get downing in 2007, a batch of SEOs took topographic point due to recognition deficit and hapless fiscal public presentation. The end of this literature reappraisal is to analyze the different features of publishing extra equity. In a first portion, the principle, costs and benefits of different publishing methods in the UK will be examined. The 2nd portion will be focused on academic research documents analyzing US SEOs. Due to assorted similarities found by bookmans ( capital markets construction and SEO observations ) , the US will be a placeholder for Japan and the UK a placeholder for EU states every bit good as for Canada.
The three chief issue methods in the UK are Rights Issue, Open Offer and Placing.
When executing a Rights Offer, every current stockholder at the clip of the proclamation will be given the right to subscribe to freshly issued equity at a pro-rata footing ( UK Listing Authorities, 2000 ) . This means that for every X portions owned by a stockholder, the latter has the right to purchase a new one. If stockholders do n’t desire to exert their rights, they can sell it on the secondary market. The compensation they get from this merchandising is normally tantamount to the loss ensuing from the dilution of ownership. Stockholders will sell their unexercised rights to the investment banker. The latter will happen other investors willing to take up these rights, normally current institutional stockholders of the company. Rights Issues are normally underwritten by a fiscal mediator ( typically investing Bankss or mobs of stockholders ) unless particular fortunes such as fiscal hurt. One of the chief benefit that can be extrapolated from Armitage ‘s survey ( 2000 ) is the fact that Rights Issues, whether they are insured or non, have a lower cost compared to Open Offers and Placings. Costss associated with each publishing method will be discussed in more item subsequently on. However, two disadvantages linked to Rights Offer can be observed. First, the market reaction to the proclamation will take to a negative unnatural return of 2 % . Second, the monetary value at which the new portions are issued display a price reduction of 15.75 % from the current market monetary value ( Korteweg and Renneboog, 2003 ) .
Firms desiring to publish new equity by Placings will engage an investment banker, besides called issue director. This investment banker will buy new issue portions and resell them to institutional investors. As the investment banker bears hazard of issue failure, in this instance under-subscription hazard, he will be compensated by a placing fee. The fixed monetary value at which the new portions will be offered is capable to fliping to be certain every individual of them is taken-up. The maximal sum of new issue portions is limited to 5 % of the current outstanding sum of portions. This restriction can be overcome at an EGM with 75 % blessing from the stockholders. Furthermore, the price reduction at which the new portions will be issued is restricted at 10 % of the current stock monetary value ( Listing Rules, London Stock Exchange, 1998 ) . Benefits from taking a Placing are the antonym of Rights Issues ‘ disadvantaged. Placings display a lower price reduction to current market monetary value ( 4 % ) and unnatural returns linked to the SEO proclamation are positive ( 1 % ) . However, costs are higher than for Rights Offer.
Finally, the Open Offer method is really similar to a Rights Issue but differ in the regard that stockholders receive an entitlement instead than a right to buy freshly issued portions. Therefore, this entitlement can non be sold on the market and merely oversights when the issue deadline is reached. Harmonizing to the findings of Armitage ( 2000 ) , Merrett, Howe and Newbould ( 1967 ) and Slovin et al. , ( 2000 ) , a big bulk of Open Offers are insured. Furthermore, houses make up one’s minding to execute an uninsured SEO are normally houses in fiscal hurt. As for Placings, Open Offers exhibit positive unnatural returns every bit high as 3 % ( Korteweg and Renneboog, 2003 ) with a moderate price reduction to current market monetary value of 3.3 % . Nevetheless, Open Offers ‘ costs are, every bit good as for Placings, higher than costs relative to Right Issues.
Barnes and Walker ( 2006 ) stipulate that is it common for UK houses choosing for an Open Offer to unite with a conditional Placing. As a consequence of this observation, the two research workers have decided to concentrate their work on SEO pick between Rights Offering and Placings. Barnes and Walker ( 2006 ) came up with a binary response theoretical account to calculate out what is the principle behind taking Rights Offer or Puting. The variables used in the theoretical account were all linked to four chief drivers identified by the bookmans: institutional features of the market, features of issuer and issue, ownership and control issues, and jobs related to proprietary information. Descriptive statistics ensuing from the theoretical account state us that on norm, houses taking rights offers are older and had poorer fiscal public presentation than houses choosing for Placings. The size of the company does n’t look to hold any influence on the choice procedure. High degrees of dissymmetry or proprietary information tend to prefer the usage of Placings. Having a high degree of institutional stockholders in the capital construction decreases the chance of picking Placings. Furthermore, rights issuers are looking to raise a significantly higher sum of capital, and the price reduction to pre-issue stock market monetary value is higher than for issues made via Placings. However, Barnes and Walker ( 2006 ) did n’t happen market liquidness and monetary value snap as important variables explicating the pick of a method over another as old theoretical plants from Kothare ( 1997 ) and Hodrick ( 1999 ) suggested. Finally, corporations publishing by Rights Offer have a well lower market to book ratio than companies utilizing Placings, which confirms a old academic paper from Slovin, Sushka and Lai ( 2000 ) .
In another survey, Korteweg and Renneboog ( 2003 ) have opposed Rights Issues to Open Offers and studied the principle behind the pick between the two methods. They came to the decision that the basicss behind that pick were the liquidness of the rights market, future growing chances for the house, involvements of managers and the stock market uncertainness. Issuers will prefer Rights Issues when the house has low growing positions and managers or institutional investors hold a big portion interest ( avoid dilution ) . When there is high market volatility, an illiquid market for rights and when the equity issue is big, issuers will be given to prefer Open Offers.
In the UK, a survey from Armitage ( 2000 ) permitted to cipher the costs associated with SEOs. Over a sample of more than a 1000 issue houses, entire cost in per centum of gross returns sums for 8.3 % for Uninsured Rights, 6.61 % for Underwritten Rights and 11.43 % for Open Offers and Placings. The fact that Armitage regroups Open Offers with Placings confirmed Barnes and Walker ‘s ( 2006 ) work stipulating that Open Offers are frequently combined with Placings. Investigating this more closely, Armitage separated subventioning cost from non-underwriting cost. The latter incorporates costs such as advisors, legal, adviser or scrutinizing fees every bit good as the cost paid to the exchange on which the issue takes topographic point. It has been found that underwriting costs for Uninsured Rights represent 0.86 % when non-underwriting costs sum for 7.44 % of the gross returns. The fact that underwriting costs for Uninsured Rights are non equal to zero prevarications in the fact that, even if the house does n’t engage an investment banker, it still needs to pay securities firm fees that are considered as an underwriting cost. For Standby Rights, the underwriting cost is of 1.88 % and non-underwriting cost sum up to 4.73 % . Finally, for Placings and Open Offers, the underwriting cost peers to 1.66 % whereas the non-underwriting cost peers to 9.76 % .
The fact that the big bulk of UK publishing houses choose to see their offering is explained by a negative perceptual experience from the market of companies taking non to take investment bankers ( Korteweg and Renneboog, 2003 ) . Indeed, the market frequently thinks that the company is n’t good plenty for fiscal mediators to take the underwriting hazard. This state of affairs is really different from what happens in the US where the principle behind the pick of subventioning the issue is the low expected take-up from bing stockholders.
Main issue methods used in the US to raise extra equity are steadfast committedness offers, best attempt offers, rights offers, rights offers with standby underwriting and private arrangements.
Rights Offers give to show stockholders the right, materialized by a warrant, to purchase extra equity at a pro-rata footing. This right can be considered as an option to either purchase the freshly issued securities or sell the warrants to other investors. These warrants normally last for 20 yearss on norm. Every portion that has n’t be sold ( unsubscribed portion ) will be proposed to other current stockholders. Firms offer a typical 15 to 20 % price reduction over market monetary value to bing stockholders for the freshly issued stocks. Rights Offers can be underwritten by a fiscal mediator ( typically investing Bankss, agents, any major stockholder of the house or external investors such as financess ) so that the publishing company has the insurance non to hold any unsubscribed portion at the terminal of the procedure. This insurance comes with a cost as the investment banker bears risk through a contractual duty to purchase any left over stocks.
Harmonizing to Eckbo and Masulis ( 1995 ) , the cost of raising capital in the US through uninsured rights sums to 1.8 % of the entire returns obtained by industrial houses and 0.5 % for public-service corporations. These costs are basically composed of legal fees, naming fees, SEC enrollment fees and province revenue enhancements. While executing uninsured rights in the US, 60 % of the returns about to be raised are pre-allocated to big stockholders thanks to subscription pre-commitments and the full sum of the extra equity is to the full distributed before the terminal of the subscription period.
For a US standby offer, houses have to pay an underwriting fee to the fiscal intermediary consisting in a take-up and fixed committedness fee. Costss for US industrial and public-service corporation houses are higher than for uninsured rights offers and sum for 4 % and 2.4 % of the gross returns, severally. Standby rights allow the company to obtain more than 70 % in subscription rate. This reasonably good consequence besides reduces the hazard taken by investment bankers. The typical investment banker take-up in standbys is 15 % of the issue ( Singh, 1992 ) .
With a Private arrangement, the company does non trust on a fiscal mediator to assist raise extra equity but on private groups of investors. Another method available to US companies is the Best Attempt Offer. In this instance, the publishing company bears the hazard of offer failure as the fiscal mediator, in this instance an investing bank, merely plays the function of a selling agent. Private arrangements represented merely a little fraction of seasoned equity offerings until the mid 80s in the US. During the 1990s, the usage of private arrangements has significantly increased ( Eckbo and Masulis, 1995 ) .
In a Firm Commitment contract, the investing bank acts as a selling agent and enters in an underwriting understanding with the issuer, vouching the house to put every equity stock issued at an agreed-upon monetary value. The underwriting fee paid by the publishing company to the investment banker is a consequence of a bilateral dialogue between the house and the bank or by a competitory command affecting several investing Bankss put into competition. In contrast with Rights Issues, stockholders are non given an option to buy the freshly issued equity. Firm committedness offers ‘ costs are typically 6.1 % for industrial US corporations and 4.2 % for public utilities. Bhagat and Frost ( 1986 ) found that subventioning compensation for negotiated contracts is much higher than for competitory command contracts. As for every method affecting an underwriting contract, Firm Commitments allow the company desiring to finish a SEO to hold the insurance that all the new equity stocks are traveling to be subscribed.
Shelf Issues, besides called Shelf-Registered Corporate Equity Offering, allow the company to fix up to two old ages in progress its SEO. Therefore, if the house fulfilled SEC demands ( $ 700m of market capitalisation or $ 1bn of debt issued over the past three old ages ) , it can raise extra capital every bit shortly as the clip is right, blowing no clip in the procedure. Bhagat, Marr and Thompson ( 1985 ) concluded that costs linked to shelf offerings are diminishing. However, Denis ( 1993 ) has found contradictory consequences due to “ choice prejudices and the inclusion of zero underwriting fee bought trades in the shelf sample ” . Shelf Issues ‘ chief benefit lies on the fact that they allow the issuer to fix up to two old ages in progress its equity offering. Therefore the corporation is able to be agile when the clip is right and execute a successful offer.
Until the 1950s, SEOs in the US were chiefly done through uninsured rights and standby floatation methods. This form changed in favour of steadfast committednesss as chief attack to raise extra equity. Rights Offers are chiefly used in states with modest capital markets and hence little equity capitalisation. This is the instance for Canada and European states whereas approximately 80 % of Nipponese and US ‘ SEOs are done through house committednesss ( Eckbo, Masulis, 1992 ) . However, harmonizing to a recent publication from Autore, Kumar and Shome ( 2008 ) , there was a singular displacement from traditional publishing methods that were mostly used in the 1980s to shelf issues that now represent the favorite option to raise extra equity. In the US, shelf-registered equity offerings outperform historical methods ( e.g. steadfast committedness or rights offers ) both in footings of entire capital raised and frequence.
The US “ Rights Offer Paradox ” , as documented by Eckbo and Masulis ( 1992 ) and Smith ( 1986 ) , stipulates that even if Public Issues such as Firm Committednesss are more dearly-won than Rights Offer, indirect costs linked to the latter push the bulk of US houses towards Public Issues. In add-on, Bhide ( 1993 ) , among others, documented that US capital markets encourage dispersed ownership and are really concerned about market liquidness. Public Issues allow for both scattering of ownership and minimisation of trading spreads, which can explicate the principle of choosing Public Issues.
Several decisions can be drawn from this literature reappraisal. First, there are three chief equity-issuing methods in the UK: Rights Issue, Open Offer and Placing. For each of these methods, the company has the pick to see or non the SEO. Most houses choose to subvention the issue because of the market reaction. Rights Issues are less dearly-won but display a negative unnatural return and have a bigger price reduction than for other methods. Open Offers and Placings are more expensive for corporations but have a positive unnatural return and a smaller price reduction. In the US, the chief issue methods are Firm Commitment Offers, Best Effort Offers, Rights Offerings, Private Placements and Shelf-Issues. A Rights Offer is really similar to its UK opposite number. It is besides cheaper than Firm Commitments and allows the house to hold a really good subscription rate. Firm Commitments are more expensive than RO, but their cost can be reduced while put to deathing a competitory command between investing Bankss. Firm Commitments have become the most popular method but have now to vie with Shelf-Issues as the latter possesses a clear benefit in their ability to be triggered rapidly.