Ž .
Journal of Empirical Finance 7 2000 113–141 www.elsevier.com
rlocatereconbase
Conditional event studies, anticipation, and asymmetric information: the case of seasoned
equity issues and pre-issue information releases
Lin Guo
a,
, Timothy S. Mech
b
a
Department of Finance, School of Management, Suffolk UniÕersity, Boston, MA 02108 USA
b
Faculty Box a2697, GroÕe City College, GroÕe City, PA 16127 USA Accepted 20 February 2000
Abstract
Information disclosed before equity issue announcements could reduce the price drops at Ž .
the announcements by 1
reducing uncertainty about managers’ private information, Ž .
and ror 2 helping investors to anticipate the equity issues. To distinguish between these
effects, we examine the determinants of firms’ decisions to issue equity, and develop a w
conditional event-study procedure, based on Acharya Acharya, S., 1988, A generalized econometric model and tests of a signaling hypothesis with two discrete signals, Journal of
x Finance, 43, 413–429. , that distinguishes between anticipation and asymmetric informa-
tion. After controlling for differences in uncertainty across firms, we present evidence that stock split declarations, dividend announcements and earnings releases help investors to
anticipate equity issues, but do not reduce asymmetric information. q 2000 Elsevier Science B.V. All rights reserved.
JEL classification: G32; G14 Keywords: Conditional event study; Seasoned equity issues
1. Introduction
Stock prices tend to fall when firms announce their intention to issue additional shares of stock. Studies of seasoned equity issues often attribute this phenomenon
Corresponding author. Tel.: q1-617-573-8388; fax: q1-617-573-8345.
Ž .
E-mail address: lguoacad.suffolk.edu L. Guo . 0927-5398
r00r- see front matter q 2000 Elsevier Science B.V. All rights reserved. Ž
. PII: S 0 9 2 7 - 5 3 9 8 0 0 0 0 0 0 7 - 4
to asymmetric information, i.e. the superior information held by managers relative to shareholders.
1
Numerous economists have investigated whether pre-issue dis- closures can alleviate the adverse-selection problem associated with new equity
Ž .
issues. Ambarish et al. 1987 , for example, argue that corporate insiders can use dividends and new issues together to communicate private information at lower
Ž .
cost than new equity issues alone. Korajczyk et al. 1992 argue that information disclosures arrive discretely, so that information asymmetry varies over time. This
suggests that the disclosure of credible information reduces uncertainty about managers’ private information, and hence reduces the price drop at subsequent
issue announcements.
Both of these models suggest that pre-issue information releases can reduce asymmetric information before equity issues. We test this implication by exploring
the effects of information releases on issue announcement returns. Previous studies in this area have used the traditional event study method, which regresses
announcement period returns on selected cross-sectional variables. However, this traditional method cannot distinguish whether a variable affects asymmetric
information, or the investors’ anticipation of the issue. In contrast, we modify
Ž .
Acharya 1988 conditional event study method to test for asymmetric information after controlling for anticipation.
2
Ž .
Conditional event study procedures, described by Acharya 1988 , Eckbo et al. Ž
. Ž
. 1990 , and Prabhala 1997 , link event day returns to the private information
revealed by the events. These procedures assume that the amount of private information revealed by an event depends on both the public information available
and the amount of uncertainty about the managers’ private information. Until now, conditional event studies have allowed the public information to vary across firms,
but hold the uncertainty about private information constant. Obviously, this is a simplifying assumption because uncertainty varies substantially across firms and
over time. Consequently, we modify the Acharya conditional event study method to allow for this variation in uncertainty. This permits us to test hypotheses about
asymmetric information, after controlling for anticipation.
We use our method to examine whether stock split declarations, dividend announcements, and earnings releases reduce asymmetric information at subse-
quent equity issue announcements. We choose these three types of information releases because the timing of these events are closely related to equity issues.
Ž .
Korajczyk et al. 1991 find that earnings are disclosed more frequently before Ž
. issue announcements than afterward. Loderer and Mauer 1992 present evidence
that firms time stock offerings immediately after dividend declarations. Guo and
1
Ž .
Ž .
For example, see Myers and Majluf 1984 , Masulis and Korwar 1986 , Asquith and Mullins Ž
. Ž
. 1986 , Mikkelson and Partch 1986 .
2
Ž .
Ž .
Ž .
Malatesta and Thompson 1985 , Bhagat and Jefferis 1991 , and Chaplinsky and Hansen 1993 also recognize the importance of partial anticipation in event studies. However, their methods do not
address the cross-sectional differences in firms’ asymmetric information.
Ž .
Mech 1997 observe that stock splits are declared much more frequently before issue announcements than afterward.
After controlling for anticipation and cross-sectional differences in asymmetric information, we find no evidence that split declarations, dividend announcements,
or earnings releases decrease the information asymmetry around equity issue announcements. Our work contributes to the literature in four additional ways.
First, we present a model and evidence concerning determinants of firms’ equity-
Ž .
Ž .
issue decisions. Choe et al. 1993 , Jung et al. 1996 , and Opler and Titman Ž
. 1995 present evidence on firms’ choice between debt and equity issues. Pagano
Ž .
et al. 1998 analyze factors that affect Italian firms’ decision to go public.
However, none of the previous empirical studies has examined the issue and no-issue choice of public firms. Second, we use a much larger and more recent
Ž .
sample than previous studies. Korajczyk et al. 1991 examine whether earnings releases reduce asymmetric information before equity issues for the period of
Ž .
1978–1983. Loderer and Mauer 1992 investigate whether pre-issue dividend announcements reduce the price drops at the issue announcements for the period
of 1973–1984. Our sample covers seasoned equity issues between 1980 and 1994. Third, we consider jointly the effects of dividend declarations, earnings releases,
and stock split declarations on issue announcement returns, after controlling for
Ž .
cross-sectional differences in uncertainty. Korajczyk et al. 1991 and Loderer and Ž
. Mauer 1992 only examine the effect of a single announcement, such as earnings
releases or dividend declarations, on issue announcements. The effects of other information releases are therefore not controlled in their analyses. Finally, we also
address a technical difficulty that has received scant attention in the conditional event-study literature. Conditional event-study procedures frequently estimate the
ex-ante probability of an event from a logit or probit regression, using announce- ment data. The probability of an event, however, differs from the probability that
it will be announced on any given day. This introduces a subtle sampling bias that can be corrected by introducing a parameter for the managers’ decision horizon.
The remainder of the paper is organized as follows. Section 2 defines our measure of asymmetric information and describes our conditional event-study
procedure. Section 3 presents the testable hypotheses. Section 4 describes the data and sample. Section 5 applies our conditional event-study procedure to study the
effects of pre-issue information releases on equity issue announcements. The paper concludes with Section 6.
2. Asymmetric information, anticipation, and conditional event studies
