Directory UMM :Data Elmu:jurnal:J-a:Journal Of Banking And Finance:Vol24.Issue9.2000:
Journal of Banking & Finance 24 (2000) 1491±1513
www.elsevier.com/locate/econbase
Changes in systematic risk following global
equity issuance
Latha Ramchand *, Pricha Sethapakdi
Department of Finance, College of Business Administration, University of Houston, Houston,
TX 77204-6282, USA
Received 13 March 1999; accepted 16 July 1999
Abstract
This paper examines changes in systematic risk following global equity issues by US
®rms. Models of market segmentation show that if international capital markets are not
fully integrated and demand curves for securities are downward sloping, ®rms issue
equity at higher prices by issuing in multiple markets compared to issuance on a single
domestic market. This would imply a reduction in the ®rmÕs cost of capital and an
increase in ®rm value. Using a sample of global equity oers during 1986±1993, we ®nd
that US ®rms that issue equity abroad experience a decline in systematic risk subsequent
to issuance. After controlling for size, volume, and leverage eects, we ®nd that this
decline in systematic risk is larger in magnitude for global compared to a control sample
of domestic equity issues. The larger the proportion of the oer sold abroad and the
larger the increase in trading volume, the bigger the decline in systematic risk. Using a
two-factor global risk model we ®nd that while ®rms issuing equity abroad experience a
decline in the domestic component of systematic risk, the foreign component increases.
Overall, however, the net eect is a decline in the cost of capital. Ó 2000 Elsevier
Science B.V. All rights reserved.
JEL classi®cation: F30; G15
Keywords: Global; Equity; Systematic; Risk; Capital
*
Corresponding author. Tel.: +1-713-743-4769; fax: +1-713-743-4789.
E-mail address: ramchand@jetson.uh.edu (L. Ramchand).
0378-4266/00/$ - see front matter Ó 2000 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4 2 6 6 ( 9 9 ) 0 0 0 9 4 - 1
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1. Introduction
The internationalization of security markets has enabled ®rms worldwide to
seek and obtain alternative sources of capital. While US ®rms have been listing
on foreign markets since the 1960s, a more recent phenomenon involves global
equity oerings by US ®rms. 1 A global equity oer involves the simultaneous
sale of equity by a US ®rm on the US and one or more foreign markets. The
development of this market can be traced to the late 1980s. While there were a
couple of global equity issues in 1983, the real origins of this market can be
traced to 1985 when there were a total of 12 issues. The total amount of global
equity raised was roughly $600 million. By 1993 both the total number of issues
as well as the total volume of global equity issued by US ®rms had increased
nearly sevenfold ± a total of 99 issues were made that raised close to $4 billion
in equity. The proportion of the oer raised abroad is on average 21%. Increasingly, larger equity issues are being oered for sale on multiple markets.
As Chaplinsky and Ramchand (1998) document, while 60% of oers in excess
of $100 million were oered in multiple markets in the period 1989±1991, this
proportion had increased to 70% for 1992±1995. The trend seems to be for US
®rms desiring to issue large amounts of equity to raise capital on multiple
markets.
The motivations to issue global equity are similar to those found in the
literature on cross-border listings: 2 to enhance the liquidity of the ®rmÕs shares
by increasing heterogeneity of the investor base and to reduce the ®rmÕs cost of
capital. Such oers are believed to increase demand and hence share price and
market value. With downward sloping demand curves for the ®rm's shares,
global equity oers lead to a rightward shift of the demand curve. This reduces
the price pressure eects when equity is raised leading to a higher share price
and hence market value relative to oers that are sold exclusively on domestic
markets. Chaplinsky and Ramchand (1998) document that the negative price
reaction at announcement associated with equity oers is signi®cantly lower for
global compared to domestic oers by 0.8%.
Global equity issuance can also be undertaken with the strategic objective of
gaining a foothold in a foreign market so as to link the ®rmÕs product and
capital markets. Investment bankers and ®rms also cite reduction in stock price
volatility as another reason for doing a global as opposed to a domestic oer.
Stock price volatility is driven by systematic as well as unsystematic risk.
Placing shares in the hands of foreign investors, it is believed could make these
securities less sensitive to domestic systematic risk. On the other hand, this
could increase the ®rmÕs exposure to foreign market shocks including changes
1
2
See Chaplinsky and Ramchand (1998).
See Stapleton and Subramanyam (1977), Alexander et al. (1987) and Karolyi (1998).
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1493
in exchange rates and foreign interest rates. Changes in risk are important not
merely for theoretical reasons but also since they aect the required rate of
return on equity and hence the ®rm's cost of capital, which is of concern to
managers.
This paper examines changes in systematic risk subsequent to the issue of
equity by US ®rms in multiple markets (global oers). We examine a sample of
global oers from 1986±1993 and document changes in stock price volatility
and systematic risk after the issue. Based on changes in risk we then document
the changes in cost of capital, if any, for ®rms that issue on foreign markets.
Speci®cally we examine changes in stock price volatility and systematic (beta)
risk with respect to the domestic (US) market for US ®rms that issue equity
abroad. These changes are measured around a 250 day trading window both
before and after the event as well as using a 48 month window before and after
the event. We then compare these changes to changes in domestic beta risk for
a control sample of ®rms issuing equity on domestic markets only. Following
this, we examine if global equity issuance is also accompanied by changes in
exposure to foreign market risk. Using the results on changes in systematic
risk, both domestic and foreign, we examine changes in the cost of capital in
the context of a two-factor model. Changes in risk ought to aect investorsÕ
rates of return. Using methodology similar to that employed in Ritter (1991)
and Foerster and Karolyi (1998a,b) we examine the pattern of abnormal returns of global issuers the year after the oer relative to returns for ®rms that
raise equity on domestic markets.
Our results indicate that beta estimates decline subsequent to equity issuance, consistent with the decline in ®nancial leverage. 3 We also ®nd that after
controlling for changes in trading volume and issue characteristics, ®rms issuing abroad experience a greater decline in beta compared to ®rms issuing
equity on domestic markets only. We con®rm the robustness of our results
using monthly returns as well as by using a pooled cross-section/time series
regression. We also ®nd that the larger the proportion of the issue raised
abroad, greater is the decline in systematic risk subsequent to the oer. Using a
two-factor model with the domestic and a foreign index as the two factors, we
®nd that for global issues, while the domestic component of systematic risk
(domestic beta) declines, the systematic risk with respect to the foreign market
(foreign beta) increases, subsequent to the issue. The net eect is a decline in the
3
This is consistent with the results in Denis and Kadlec (1994). Denis and Kadlec (1994)
demonstrate how changes in trading activity associated with the issuance of equity can lead to
biased estimates of systematic risk. They demonstrate how OLS regressions can result in increases
in beta estimates following equity issuance since these estimates do not correct for changes in the
frequency of trading. They further show that when these changes are accounted for using the
Scholes and Williams (1977) correction procedure, consistent with a leverage eect, beta declines
following equity issues.
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
overall cost of capital although the decrease is not signi®cant. Finally there is
some evidence to suggest that global issues experience a signi®cantly higher
one-year return compared to domestic issues.
The remainder of this paper is organized as follows: Section 2 examines the
theoretical motivations for global equity issuance and its impact on risk.
Section 3 describes our data. Section 4 reports the empirical results on changes
in stock price volatility and trading volume and systematic risk for global issues
and compares them to a control sample of domestic issues. This section also
examines the implications of changes in systematic risk on the cost of capital
using a two-factor model as in Karolyi (1998). Section 5 gives our conclusions.
2. Global issuance and changes in risk
If international capital markets are not completely integrated and demand
curves are downward sloping, a global equity issue can, by shifting the demand
curve to the right, mitigate the downward price pressure on prices when new
equity is issued. This would imply a higher price for the shares and hence a
reduction in the cost of capital to the ®rm. Market segmentation could result
from various factors ranging from legal investment barriers to taxes and
transactions costs. Models of market segmentation suggest that any activity by
the ®rm that lowers the cost of segmentation can enhance ®rm value. 4 A
global issue could also result in a lowering of the transactions and information
costs associated with the purchase of these securities by foreign investors.
Parsons and Raviv (1985) and Benveniste and Spindt (1989) point out that the
marketing eorts accompanying a ®rm-commitment oer can potentially increase the oer price for an issue. While foreign investors can purchase these
securities on a US exchange even in the absence of a global oer, the selling
activities associated with a global oer can reduce the information costs faced
by foreign investors. The introduction of a new market competing for order
¯ow could also reduce trading costs. 5 Finally, to the extent that global issues
aord foreign investors tax bene®ts relative to purchases of securities directly
on a US exchange, the return on these securities could be lower. All these
factors imply that if capital markets are segmented, securities oered on
global markets will command a higher price and hence lower the ®rm's cost of
capital.
Segmentation of markets could also lead to changes in systematic risk when
®rms access foreign capital markets. Previous studies on the eect of cross-
4
See Black (1974), Stapelton and Subramanyam (1977), Stulz (1981), Errunza and Losq (1985),
Alexander et al. (1987, 1988) and Stulz and Wasserfallen (1995) for models of market segmentation.
5
See Chowdhury and Nanda (1991) and Domowitz et al. (1997, 1998).
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1495
border listings ®nd that subsequent to the listing, ®rms experience changes in
the domestic market beta. 6 These studies also ®nd that such listings lead to
changes in systematic risk while keeping overall variances unchanged. 7 For
cross-listed stocks, changes in systematic risk result from changes in exposure
to both the domestic as well as the foreign market. To the extent that the
domestic and foreign markets are not completely integrated, foreign listings
increase the exposure of the ®rmÕs returns to foreign market ¯uctuations as well
as changes in exchange rates. For instance, Howe and Madura (1990) ®nd that
for US ®rms listing in Europe or Japan, domestic betas measured with respect
to the S&P 500 index drops while the beta with respect to the foreign market
increases. 8 Further, Varela and Lee (1993) ®nd that US ®rms listing in London
experience a decline in the cost of capital to the tune of 240 basis points subsequent to listing. As a complement to this literature, Foerster and Karolyi
(1999) ®nd that foreign ®rms listing in the US experience a decline in their local
market betas while global market risk is unchanged. 9 Jayaraman et al. (1993)
report that the listing of American Depositary Receipts results in a permanent
increase in risk and return of the underlying securities (see also Miller, 1999).
Generalizing these ®ndings on cross-listings to equity issues would suggest that
equity issues by US ®rms on a foreign market could also result in changes in
systematic risk.
It should be noted, however, that equity issuance on a foreign market does
not automatically imply that the shares are listed on the foreign market. In fact
only a small proportion of the ®rms in our sample (22%) also list their shares
abroad. At the same time ®rms need not always issue equity on markets where
they are also listed. Listing could have a dierent impact on trading volume
and trading patterns when compared to issuance. For instance, ®rms that issue
equity but do not have a foreign listing could experience a decline in trading
volume if foreign investors do not trade as frequently, either because their
objectives are dierent or because they face signi®cant transactions costs.
Foerster and Karolyi (1998a) ®nd that post-issue abnormal returns of foreign
®rms issuing equity in the US are positively related to the magnitude of trading
volume shifted to the US market. For US ®rms issuing abroad, the same need
not be true to the extent that the proportion of trading volume shifted abroad
may not be as high as that of foreign ®rms issuing in the US. This would imply
a smaller increase in the systematic risk with respect to the foreign index.
6
See Karolyi (1998) and Stulz (1998) for an exhaustive review of this literature.
See Howe and Kelm (1987), Lee (1991), Torabzadeh et al. (1992), Damodaran et al. (1993),
Varela and Lee (1993), Lau et al. (1994), Rothman (1995), Foerster and Karolyi (1998a,b).
8
Also see Torabzadeh et al. (1992), and Damodaran et al. (1993).
9
Karolyi (1998) uses a multi-factor model to study the impact of changes in the components of
systematic risk on the ®rmÕs cost of capital and ®nds that non-US ®rms listing in the US experience
a decline in the cost of capital averaging 114 basis points.
7
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
To the extent that the foreign tranche of the equity oer subsequently results in
a ``¯ow-back'' to the domestic market, these eects will be reduced resulting in
risk and return remaining unchanged. The change in systematic risk is important since it impacts on the required rate of return and hence the ®rm's cost
of capital. Whether or not systematic risk and hence the required rate of return
declines, is an empirical issue that we examine below.
3. Data
Our sample consists of global equity oers made by US ®rms during 1986±
1993. 10 By global oer we refer to the simultaneous sale of equity by a US ®rm
on the US and one or more foreign markets. This de®nition is largely an artifact of the data we use in which all issues involve a foreign as well as a domestic tranche. The domestic tranche varies anywhere from 11% to 50% with
an average of 21%. While the prospectuses state the amount of the oer to be
sold in the foreign tranche, there is almost always no mention of the exact
foreign market where the issue will be sold. The prospectuses merely state that
a certain percentage of the issue will be sold outside the US. All oers in this
sample are seasoned equity oers (SEOs).
Since all the issues in this sample involve simultaneous issues in the domestic
as well as one more foreign markets, these oers do have to meet SEC requirements and have to be oered for sale at the same price on all markets. The
tax implications on these securities are no dierent from those relevant for US
holdings by foreign investors in general and are detailed in the prospectus.
Furthermore, the institutional details of the marketing process are similar to
those of a domestic oer except for the fact that the underwriting syndicate
comprises international underwriters who, in general, are the international
aliates of the domestic book manager. Also, as explained in Chaplinsky and
Ramchand (1998), these oers are almost always marketed at least initially to
foreign institutional investors.
We restrict our attention to ®rm commitment oers made by industrial
®rms, all of which involve the sale of primary shares. 11 By primary we refer to
new shares as opposed to the sale of existing shares. We also eliminate from
our sample equity oerings connected with closed-end investment funds. Our
sample includes 309 issues by 262 ®rms of which there are 190 NYSE/AMEX
10
This sample is a subset of the global equity issues used in Chaplinsky and Ramchand (1998)
obtained from the New Issues Database of the Securities Data Company (SDC).
11
We exclude equity oerings by utilities and ®nancials as well as those by closed-end investment
funds.
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1497
and 72 NASDAQ ®rms. 12 For all of our oers we require stock return data
from the Center for Research in Security Prices (CRSP) as well as company
speci®c information from the COMPUSTAT tapes. Since we examine changes
in systematic risk using daily returns as well as monthly returns we require data
on daily returns around a 250 day window both before and after the event as
well as monthly returns around a 48 month window before and after the event.
As a result of this our ®nal sample reduces to 147 issues of which 122 are
NYSE/AMEX ®rms and 25 are NASDAQ. 13
Our control sample of domestic equity issues is obtained from the Disclosure 33 CD database. The control sample is limited to primary equity issues
that are sold in the US market only. To ensure proper control we also eliminate
from this group closed-end investment funds and OTC ®rms. The control
sample is constructed in the following manner:
Step 1: For every global issue, we choose a domestic issue that is closest in
®rm size to the global issue. This is done using the ®rmÕs market value of equity
(MVEQ) prior to the issue.
Step 2: We then choose from among the subset of the domestic issues that
are ®rm size matched, that issue which is closest in terms of the issue date to the
global issue. 14
Since trading volume changes induced by equity issuance could be dierent
across NYSE/AMEX versus NASDAQ ®rms, throughout the paper we separate the two groups. 15 Table 1 reports issue characteristics of NYSE/AMEX
and NASDAQ ®rms separately. From Panel A, the average size of global
12
There are 4 OTC ®rms that are eliminated from this sample.
Our analysis of systematic (beta) risk is based on daily returns over a 250 day period both
prior to and after the event. In addition, we estimate monthly betas using a 48 month horizon prior
to and after the event. If the ®rm does not have at least 50 observations of daily returns both prior
to and after the event or if it does not have at least 30 months of data prior to and after the event, it
is eliminated from the sample. The binding constraint is the requirement of 30 monthly returns
before and after the event, which eliminates ®rms that made initial public oerings within a 2 yr
period prior to our oer date (the median time between IPO and the seasoned oer for ®rms in our
sample is 29 months). This reduces the sample size to 174 issues. The remaining loss is due to lack of
®nancial data on COMPUSTAT. All results on global issues in Tables 1±5 are based on this ®nal
sample of 147 ®rms.
14
We did analyze the results using two other ways : One, matching by asset size prior to the issue
and then by issue date and two, by matching using book-to-market ratios prior to the oer and then
by the issue date. The results using these methods are qualitatively identical to those reported in the
paper.
15
Size, both issue size and ®rm size, would be one reason to separate the NYSE/AMEX from the
NASDAQ ®rms. Dierences in size are often used as proxies for risk. Hence, the dierences
reported across these two categories could be associated with risk dierences. It could also be due to
dierences in liquidity across the two markets leading to dierential changes in systematic risk after
equity issue. Bessembinder and Kaufman (1997) show that trading costs on the NYSE measured as
realized bid±ask spreads are lower than those on the NASDAQ by a factor of two to three.
13
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
Table 1
Variable
NYSE/AMEX
NASDAQ
a
Panel A: ± Issuer characteristics of global issues ± 1986±1993
Issue size ($ millions)
$250
# Shares issued (millions)
7.67
% Issued abroad
21%
# Shares issued abroad (millions)
1.53
Size/MVEQ
0.19
MVEQ ($ millions)
$1823
CAR 1; 1
ÿ0.023
Change in D/E
ÿ0.29
N
122
$67
2.78
22%
0.59
0.35
$322
ÿ0.026
ÿ0.03
25
Panel B ± Number of issues by year of issue
Year
NYSE/AMEX
NASDAQ
Totalb
1986
1987
1988
1989
1990
1991
1992
1993
0
2
0
2
4
7
4
6
6
10
7
3
13
36
31
41
147
6
8
7
1
9
29
27
35
a
Size is the issue size in millions of dollars. # Shares Issued is the number of shares oered for sale
in millions. % Issued Abroad is the proportion of the issue sold abroad. # Shares Issued Abroad is
the number of shares in millions oered for sale in the foreign markets. Size/MVEQ is the size of the
issue relative to the market value of the issue at the time of the oer. MVEQ is the market value of
the ®rm's equity at the time of the oer in millions of dollars. CAR (ÿ1,+1) is the cumulative
abnormal return calculated around a 3 day window relative to the announcement date of the oer
using market adjusted returns and change in D/E is the change in the debt to equity ratio after the
issuance of equity. N denotes the number of observations in each group.
b
Total denotes the total number of issues for a given year for the 147 global issues in our ®nal
sample.
*
Signi®cant at 1% level.
equity oers by NYSE/AMEX ®rms is $250 million, of which, $53 million or
roughly 21% is raised abroad. While the number of global issues has been
increasing over time (Panel B), the average proportion of the foreign equity
tranche (Panel A) has remained more or less constant at 20%. On average
global issues result in an increase in the number of shares by about 8 million for
NYSE/AMEX and 3 million for NASDAQ ®rms (Panel A). The number of
shares sold abroad is roughly 20% of the total number of shares issued and
ranges from about 1.53 million for NYSE/AMEX ®rms to about 0.6 million
for NASDAQ ®rms (Panel A). Both in terms of the average size and the
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1499
number of shares issued, global issues are much larger than domestic issues. 16
On average, global issue sizes are about 19% of the existing market value of the
®rm for NYSE/AMEX ®rms and about 35% for NASDAQ ®rms. The average
global issuer is also typically a large ®rm as evidenced by the MVEQ in Panel A
of Table 1. The mean market capitalization of the global issuer in the NYSE/
AMEX group is almost $2 billion. 17 Panel A of Table 1 also reports the average cumulative abnormal return CAR ÿ1; 1 calculated using a 3 day
window relative to the announcement date for global issues. The mean
CAR ÿ1; 1 is ÿ2.3% for NYSE/AMEX and ÿ2.6% for NASDAQ issuers
both of which are signi®cant at 1%. Chaplinsky and Ramchand (1998) report
that after controlling for ®rm size and risk, the CAR ÿ1; 1 is less adverse by
0.8% for global issues compared to domestic issues sold exclusively on the
domestic market. The last row of Panel A is the change in the debt to equity
ratio after the issuance of equity. With the issue of new equity, the debt to
equity ratio declines by 0.29 for NYSE/AMEX ®rms and declines by 0.03 for
NASDAQ ®rms.
4. Empirical results
4.1. Changes in stock price volatility and trading volume
We document the changes in volatility accompanying global issuance by
comparing pre and post issue stock price volatility. The market microstructure
literature relates changes in stock price variance to changes in volume and
trading activity. 18 Hence we do the same comparison for trading volume. 19
We also compare these changes to the control sample of domestic issues
matched by market value and date of the oer. These results are reported in
Table 2. Panel A of Table 2 reports the pre and post oer standard deviation of
the stock price for NYSE/AMEX ®rms. This is calculated around a 250-day
window relative to the listing and oer dates. More precisely the pre-oer
standard deviation is the standard deviation of the ®rmÕs stock price measured
over 250 days starting 300 days before the announcement date and ending 50
16
The average size of a comparable NYSE/AMEX domestic issue is $117 million and the MVEQ
is $1.6 billion. For NASDAQ issues the issue and ®rm size of a domestic issue are $44 and $320
million, respectively.
17
Some of the more well-known ®rms in this group are Time Warner, Occidental Petroleum,
Westinghouse Electric, Union Carbide, Union Texas Petroleum, Sears Roebuck, Motorola and
Inland Steel to name a few.
18
See Forster and Viswanathan (1993).
19
See also Christie and Huang (1993) and Foerster and Karolyi (1998a).
1500
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
Table 2
Changes in stock price volatility and trading volume: Comparison between global and domestic
oers ± 1986±1993a
Variable
Global oers
Pre-oer
period
Postoer
period
Domestic oers
Ratio/
dierence
(p-value)
Pre-oer
period
Postoer
period
Ratio/
dierence
(p-value)
Panel A ± NYSE/AMEX ®rms
Standard
0.023
0.021
deviation
0.014
0.015
Trading
0.346
0.415
volume
0.391
0.374
1.095
(0.31)
20%
(
www.elsevier.com/locate/econbase
Changes in systematic risk following global
equity issuance
Latha Ramchand *, Pricha Sethapakdi
Department of Finance, College of Business Administration, University of Houston, Houston,
TX 77204-6282, USA
Received 13 March 1999; accepted 16 July 1999
Abstract
This paper examines changes in systematic risk following global equity issues by US
®rms. Models of market segmentation show that if international capital markets are not
fully integrated and demand curves for securities are downward sloping, ®rms issue
equity at higher prices by issuing in multiple markets compared to issuance on a single
domestic market. This would imply a reduction in the ®rmÕs cost of capital and an
increase in ®rm value. Using a sample of global equity oers during 1986±1993, we ®nd
that US ®rms that issue equity abroad experience a decline in systematic risk subsequent
to issuance. After controlling for size, volume, and leverage eects, we ®nd that this
decline in systematic risk is larger in magnitude for global compared to a control sample
of domestic equity issues. The larger the proportion of the oer sold abroad and the
larger the increase in trading volume, the bigger the decline in systematic risk. Using a
two-factor global risk model we ®nd that while ®rms issuing equity abroad experience a
decline in the domestic component of systematic risk, the foreign component increases.
Overall, however, the net eect is a decline in the cost of capital. Ó 2000 Elsevier
Science B.V. All rights reserved.
JEL classi®cation: F30; G15
Keywords: Global; Equity; Systematic; Risk; Capital
*
Corresponding author. Tel.: +1-713-743-4769; fax: +1-713-743-4789.
E-mail address: ramchand@jetson.uh.edu (L. Ramchand).
0378-4266/00/$ - see front matter Ó 2000 Elsevier Science B.V. All rights reserved.
PII: S 0 3 7 8 - 4 2 6 6 ( 9 9 ) 0 0 0 9 4 - 1
1492
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1. Introduction
The internationalization of security markets has enabled ®rms worldwide to
seek and obtain alternative sources of capital. While US ®rms have been listing
on foreign markets since the 1960s, a more recent phenomenon involves global
equity oerings by US ®rms. 1 A global equity oer involves the simultaneous
sale of equity by a US ®rm on the US and one or more foreign markets. The
development of this market can be traced to the late 1980s. While there were a
couple of global equity issues in 1983, the real origins of this market can be
traced to 1985 when there were a total of 12 issues. The total amount of global
equity raised was roughly $600 million. By 1993 both the total number of issues
as well as the total volume of global equity issued by US ®rms had increased
nearly sevenfold ± a total of 99 issues were made that raised close to $4 billion
in equity. The proportion of the oer raised abroad is on average 21%. Increasingly, larger equity issues are being oered for sale on multiple markets.
As Chaplinsky and Ramchand (1998) document, while 60% of oers in excess
of $100 million were oered in multiple markets in the period 1989±1991, this
proportion had increased to 70% for 1992±1995. The trend seems to be for US
®rms desiring to issue large amounts of equity to raise capital on multiple
markets.
The motivations to issue global equity are similar to those found in the
literature on cross-border listings: 2 to enhance the liquidity of the ®rmÕs shares
by increasing heterogeneity of the investor base and to reduce the ®rmÕs cost of
capital. Such oers are believed to increase demand and hence share price and
market value. With downward sloping demand curves for the ®rm's shares,
global equity oers lead to a rightward shift of the demand curve. This reduces
the price pressure eects when equity is raised leading to a higher share price
and hence market value relative to oers that are sold exclusively on domestic
markets. Chaplinsky and Ramchand (1998) document that the negative price
reaction at announcement associated with equity oers is signi®cantly lower for
global compared to domestic oers by 0.8%.
Global equity issuance can also be undertaken with the strategic objective of
gaining a foothold in a foreign market so as to link the ®rmÕs product and
capital markets. Investment bankers and ®rms also cite reduction in stock price
volatility as another reason for doing a global as opposed to a domestic oer.
Stock price volatility is driven by systematic as well as unsystematic risk.
Placing shares in the hands of foreign investors, it is believed could make these
securities less sensitive to domestic systematic risk. On the other hand, this
could increase the ®rmÕs exposure to foreign market shocks including changes
1
2
See Chaplinsky and Ramchand (1998).
See Stapleton and Subramanyam (1977), Alexander et al. (1987) and Karolyi (1998).
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1493
in exchange rates and foreign interest rates. Changes in risk are important not
merely for theoretical reasons but also since they aect the required rate of
return on equity and hence the ®rm's cost of capital, which is of concern to
managers.
This paper examines changes in systematic risk subsequent to the issue of
equity by US ®rms in multiple markets (global oers). We examine a sample of
global oers from 1986±1993 and document changes in stock price volatility
and systematic risk after the issue. Based on changes in risk we then document
the changes in cost of capital, if any, for ®rms that issue on foreign markets.
Speci®cally we examine changes in stock price volatility and systematic (beta)
risk with respect to the domestic (US) market for US ®rms that issue equity
abroad. These changes are measured around a 250 day trading window both
before and after the event as well as using a 48 month window before and after
the event. We then compare these changes to changes in domestic beta risk for
a control sample of ®rms issuing equity on domestic markets only. Following
this, we examine if global equity issuance is also accompanied by changes in
exposure to foreign market risk. Using the results on changes in systematic
risk, both domestic and foreign, we examine changes in the cost of capital in
the context of a two-factor model. Changes in risk ought to aect investorsÕ
rates of return. Using methodology similar to that employed in Ritter (1991)
and Foerster and Karolyi (1998a,b) we examine the pattern of abnormal returns of global issuers the year after the oer relative to returns for ®rms that
raise equity on domestic markets.
Our results indicate that beta estimates decline subsequent to equity issuance, consistent with the decline in ®nancial leverage. 3 We also ®nd that after
controlling for changes in trading volume and issue characteristics, ®rms issuing abroad experience a greater decline in beta compared to ®rms issuing
equity on domestic markets only. We con®rm the robustness of our results
using monthly returns as well as by using a pooled cross-section/time series
regression. We also ®nd that the larger the proportion of the issue raised
abroad, greater is the decline in systematic risk subsequent to the oer. Using a
two-factor model with the domestic and a foreign index as the two factors, we
®nd that for global issues, while the domestic component of systematic risk
(domestic beta) declines, the systematic risk with respect to the foreign market
(foreign beta) increases, subsequent to the issue. The net eect is a decline in the
3
This is consistent with the results in Denis and Kadlec (1994). Denis and Kadlec (1994)
demonstrate how changes in trading activity associated with the issuance of equity can lead to
biased estimates of systematic risk. They demonstrate how OLS regressions can result in increases
in beta estimates following equity issuance since these estimates do not correct for changes in the
frequency of trading. They further show that when these changes are accounted for using the
Scholes and Williams (1977) correction procedure, consistent with a leverage eect, beta declines
following equity issues.
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
overall cost of capital although the decrease is not signi®cant. Finally there is
some evidence to suggest that global issues experience a signi®cantly higher
one-year return compared to domestic issues.
The remainder of this paper is organized as follows: Section 2 examines the
theoretical motivations for global equity issuance and its impact on risk.
Section 3 describes our data. Section 4 reports the empirical results on changes
in stock price volatility and trading volume and systematic risk for global issues
and compares them to a control sample of domestic issues. This section also
examines the implications of changes in systematic risk on the cost of capital
using a two-factor model as in Karolyi (1998). Section 5 gives our conclusions.
2. Global issuance and changes in risk
If international capital markets are not completely integrated and demand
curves are downward sloping, a global equity issue can, by shifting the demand
curve to the right, mitigate the downward price pressure on prices when new
equity is issued. This would imply a higher price for the shares and hence a
reduction in the cost of capital to the ®rm. Market segmentation could result
from various factors ranging from legal investment barriers to taxes and
transactions costs. Models of market segmentation suggest that any activity by
the ®rm that lowers the cost of segmentation can enhance ®rm value. 4 A
global issue could also result in a lowering of the transactions and information
costs associated with the purchase of these securities by foreign investors.
Parsons and Raviv (1985) and Benveniste and Spindt (1989) point out that the
marketing eorts accompanying a ®rm-commitment oer can potentially increase the oer price for an issue. While foreign investors can purchase these
securities on a US exchange even in the absence of a global oer, the selling
activities associated with a global oer can reduce the information costs faced
by foreign investors. The introduction of a new market competing for order
¯ow could also reduce trading costs. 5 Finally, to the extent that global issues
aord foreign investors tax bene®ts relative to purchases of securities directly
on a US exchange, the return on these securities could be lower. All these
factors imply that if capital markets are segmented, securities oered on
global markets will command a higher price and hence lower the ®rm's cost of
capital.
Segmentation of markets could also lead to changes in systematic risk when
®rms access foreign capital markets. Previous studies on the eect of cross-
4
See Black (1974), Stapelton and Subramanyam (1977), Stulz (1981), Errunza and Losq (1985),
Alexander et al. (1987, 1988) and Stulz and Wasserfallen (1995) for models of market segmentation.
5
See Chowdhury and Nanda (1991) and Domowitz et al. (1997, 1998).
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1495
border listings ®nd that subsequent to the listing, ®rms experience changes in
the domestic market beta. 6 These studies also ®nd that such listings lead to
changes in systematic risk while keeping overall variances unchanged. 7 For
cross-listed stocks, changes in systematic risk result from changes in exposure
to both the domestic as well as the foreign market. To the extent that the
domestic and foreign markets are not completely integrated, foreign listings
increase the exposure of the ®rmÕs returns to foreign market ¯uctuations as well
as changes in exchange rates. For instance, Howe and Madura (1990) ®nd that
for US ®rms listing in Europe or Japan, domestic betas measured with respect
to the S&P 500 index drops while the beta with respect to the foreign market
increases. 8 Further, Varela and Lee (1993) ®nd that US ®rms listing in London
experience a decline in the cost of capital to the tune of 240 basis points subsequent to listing. As a complement to this literature, Foerster and Karolyi
(1999) ®nd that foreign ®rms listing in the US experience a decline in their local
market betas while global market risk is unchanged. 9 Jayaraman et al. (1993)
report that the listing of American Depositary Receipts results in a permanent
increase in risk and return of the underlying securities (see also Miller, 1999).
Generalizing these ®ndings on cross-listings to equity issues would suggest that
equity issues by US ®rms on a foreign market could also result in changes in
systematic risk.
It should be noted, however, that equity issuance on a foreign market does
not automatically imply that the shares are listed on the foreign market. In fact
only a small proportion of the ®rms in our sample (22%) also list their shares
abroad. At the same time ®rms need not always issue equity on markets where
they are also listed. Listing could have a dierent impact on trading volume
and trading patterns when compared to issuance. For instance, ®rms that issue
equity but do not have a foreign listing could experience a decline in trading
volume if foreign investors do not trade as frequently, either because their
objectives are dierent or because they face signi®cant transactions costs.
Foerster and Karolyi (1998a) ®nd that post-issue abnormal returns of foreign
®rms issuing equity in the US are positively related to the magnitude of trading
volume shifted to the US market. For US ®rms issuing abroad, the same need
not be true to the extent that the proportion of trading volume shifted abroad
may not be as high as that of foreign ®rms issuing in the US. This would imply
a smaller increase in the systematic risk with respect to the foreign index.
6
See Karolyi (1998) and Stulz (1998) for an exhaustive review of this literature.
See Howe and Kelm (1987), Lee (1991), Torabzadeh et al. (1992), Damodaran et al. (1993),
Varela and Lee (1993), Lau et al. (1994), Rothman (1995), Foerster and Karolyi (1998a,b).
8
Also see Torabzadeh et al. (1992), and Damodaran et al. (1993).
9
Karolyi (1998) uses a multi-factor model to study the impact of changes in the components of
systematic risk on the ®rmÕs cost of capital and ®nds that non-US ®rms listing in the US experience
a decline in the cost of capital averaging 114 basis points.
7
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
To the extent that the foreign tranche of the equity oer subsequently results in
a ``¯ow-back'' to the domestic market, these eects will be reduced resulting in
risk and return remaining unchanged. The change in systematic risk is important since it impacts on the required rate of return and hence the ®rm's cost
of capital. Whether or not systematic risk and hence the required rate of return
declines, is an empirical issue that we examine below.
3. Data
Our sample consists of global equity oers made by US ®rms during 1986±
1993. 10 By global oer we refer to the simultaneous sale of equity by a US ®rm
on the US and one or more foreign markets. This de®nition is largely an artifact of the data we use in which all issues involve a foreign as well as a domestic tranche. The domestic tranche varies anywhere from 11% to 50% with
an average of 21%. While the prospectuses state the amount of the oer to be
sold in the foreign tranche, there is almost always no mention of the exact
foreign market where the issue will be sold. The prospectuses merely state that
a certain percentage of the issue will be sold outside the US. All oers in this
sample are seasoned equity oers (SEOs).
Since all the issues in this sample involve simultaneous issues in the domestic
as well as one more foreign markets, these oers do have to meet SEC requirements and have to be oered for sale at the same price on all markets. The
tax implications on these securities are no dierent from those relevant for US
holdings by foreign investors in general and are detailed in the prospectus.
Furthermore, the institutional details of the marketing process are similar to
those of a domestic oer except for the fact that the underwriting syndicate
comprises international underwriters who, in general, are the international
aliates of the domestic book manager. Also, as explained in Chaplinsky and
Ramchand (1998), these oers are almost always marketed at least initially to
foreign institutional investors.
We restrict our attention to ®rm commitment oers made by industrial
®rms, all of which involve the sale of primary shares. 11 By primary we refer to
new shares as opposed to the sale of existing shares. We also eliminate from
our sample equity oerings connected with closed-end investment funds. Our
sample includes 309 issues by 262 ®rms of which there are 190 NYSE/AMEX
10
This sample is a subset of the global equity issues used in Chaplinsky and Ramchand (1998)
obtained from the New Issues Database of the Securities Data Company (SDC).
11
We exclude equity oerings by utilities and ®nancials as well as those by closed-end investment
funds.
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1497
and 72 NASDAQ ®rms. 12 For all of our oers we require stock return data
from the Center for Research in Security Prices (CRSP) as well as company
speci®c information from the COMPUSTAT tapes. Since we examine changes
in systematic risk using daily returns as well as monthly returns we require data
on daily returns around a 250 day window both before and after the event as
well as monthly returns around a 48 month window before and after the event.
As a result of this our ®nal sample reduces to 147 issues of which 122 are
NYSE/AMEX ®rms and 25 are NASDAQ. 13
Our control sample of domestic equity issues is obtained from the Disclosure 33 CD database. The control sample is limited to primary equity issues
that are sold in the US market only. To ensure proper control we also eliminate
from this group closed-end investment funds and OTC ®rms. The control
sample is constructed in the following manner:
Step 1: For every global issue, we choose a domestic issue that is closest in
®rm size to the global issue. This is done using the ®rmÕs market value of equity
(MVEQ) prior to the issue.
Step 2: We then choose from among the subset of the domestic issues that
are ®rm size matched, that issue which is closest in terms of the issue date to the
global issue. 14
Since trading volume changes induced by equity issuance could be dierent
across NYSE/AMEX versus NASDAQ ®rms, throughout the paper we separate the two groups. 15 Table 1 reports issue characteristics of NYSE/AMEX
and NASDAQ ®rms separately. From Panel A, the average size of global
12
There are 4 OTC ®rms that are eliminated from this sample.
Our analysis of systematic (beta) risk is based on daily returns over a 250 day period both
prior to and after the event. In addition, we estimate monthly betas using a 48 month horizon prior
to and after the event. If the ®rm does not have at least 50 observations of daily returns both prior
to and after the event or if it does not have at least 30 months of data prior to and after the event, it
is eliminated from the sample. The binding constraint is the requirement of 30 monthly returns
before and after the event, which eliminates ®rms that made initial public oerings within a 2 yr
period prior to our oer date (the median time between IPO and the seasoned oer for ®rms in our
sample is 29 months). This reduces the sample size to 174 issues. The remaining loss is due to lack of
®nancial data on COMPUSTAT. All results on global issues in Tables 1±5 are based on this ®nal
sample of 147 ®rms.
14
We did analyze the results using two other ways : One, matching by asset size prior to the issue
and then by issue date and two, by matching using book-to-market ratios prior to the oer and then
by the issue date. The results using these methods are qualitatively identical to those reported in the
paper.
15
Size, both issue size and ®rm size, would be one reason to separate the NYSE/AMEX from the
NASDAQ ®rms. Dierences in size are often used as proxies for risk. Hence, the dierences
reported across these two categories could be associated with risk dierences. It could also be due to
dierences in liquidity across the two markets leading to dierential changes in systematic risk after
equity issue. Bessembinder and Kaufman (1997) show that trading costs on the NYSE measured as
realized bid±ask spreads are lower than those on the NASDAQ by a factor of two to three.
13
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L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
Table 1
Variable
NYSE/AMEX
NASDAQ
a
Panel A: ± Issuer characteristics of global issues ± 1986±1993
Issue size ($ millions)
$250
# Shares issued (millions)
7.67
% Issued abroad
21%
# Shares issued abroad (millions)
1.53
Size/MVEQ
0.19
MVEQ ($ millions)
$1823
CAR 1; 1
ÿ0.023
Change in D/E
ÿ0.29
N
122
$67
2.78
22%
0.59
0.35
$322
ÿ0.026
ÿ0.03
25
Panel B ± Number of issues by year of issue
Year
NYSE/AMEX
NASDAQ
Totalb
1986
1987
1988
1989
1990
1991
1992
1993
0
2
0
2
4
7
4
6
6
10
7
3
13
36
31
41
147
6
8
7
1
9
29
27
35
a
Size is the issue size in millions of dollars. # Shares Issued is the number of shares oered for sale
in millions. % Issued Abroad is the proportion of the issue sold abroad. # Shares Issued Abroad is
the number of shares in millions oered for sale in the foreign markets. Size/MVEQ is the size of the
issue relative to the market value of the issue at the time of the oer. MVEQ is the market value of
the ®rm's equity at the time of the oer in millions of dollars. CAR (ÿ1,+1) is the cumulative
abnormal return calculated around a 3 day window relative to the announcement date of the oer
using market adjusted returns and change in D/E is the change in the debt to equity ratio after the
issuance of equity. N denotes the number of observations in each group.
b
Total denotes the total number of issues for a given year for the 147 global issues in our ®nal
sample.
*
Signi®cant at 1% level.
equity oers by NYSE/AMEX ®rms is $250 million, of which, $53 million or
roughly 21% is raised abroad. While the number of global issues has been
increasing over time (Panel B), the average proportion of the foreign equity
tranche (Panel A) has remained more or less constant at 20%. On average
global issues result in an increase in the number of shares by about 8 million for
NYSE/AMEX and 3 million for NASDAQ ®rms (Panel A). The number of
shares sold abroad is roughly 20% of the total number of shares issued and
ranges from about 1.53 million for NYSE/AMEX ®rms to about 0.6 million
for NASDAQ ®rms (Panel A). Both in terms of the average size and the
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
1499
number of shares issued, global issues are much larger than domestic issues. 16
On average, global issue sizes are about 19% of the existing market value of the
®rm for NYSE/AMEX ®rms and about 35% for NASDAQ ®rms. The average
global issuer is also typically a large ®rm as evidenced by the MVEQ in Panel A
of Table 1. The mean market capitalization of the global issuer in the NYSE/
AMEX group is almost $2 billion. 17 Panel A of Table 1 also reports the average cumulative abnormal return CAR ÿ1; 1 calculated using a 3 day
window relative to the announcement date for global issues. The mean
CAR ÿ1; 1 is ÿ2.3% for NYSE/AMEX and ÿ2.6% for NASDAQ issuers
both of which are signi®cant at 1%. Chaplinsky and Ramchand (1998) report
that after controlling for ®rm size and risk, the CAR ÿ1; 1 is less adverse by
0.8% for global issues compared to domestic issues sold exclusively on the
domestic market. The last row of Panel A is the change in the debt to equity
ratio after the issuance of equity. With the issue of new equity, the debt to
equity ratio declines by 0.29 for NYSE/AMEX ®rms and declines by 0.03 for
NASDAQ ®rms.
4. Empirical results
4.1. Changes in stock price volatility and trading volume
We document the changes in volatility accompanying global issuance by
comparing pre and post issue stock price volatility. The market microstructure
literature relates changes in stock price variance to changes in volume and
trading activity. 18 Hence we do the same comparison for trading volume. 19
We also compare these changes to the control sample of domestic issues
matched by market value and date of the oer. These results are reported in
Table 2. Panel A of Table 2 reports the pre and post oer standard deviation of
the stock price for NYSE/AMEX ®rms. This is calculated around a 250-day
window relative to the listing and oer dates. More precisely the pre-oer
standard deviation is the standard deviation of the ®rmÕs stock price measured
over 250 days starting 300 days before the announcement date and ending 50
16
The average size of a comparable NYSE/AMEX domestic issue is $117 million and the MVEQ
is $1.6 billion. For NASDAQ issues the issue and ®rm size of a domestic issue are $44 and $320
million, respectively.
17
Some of the more well-known ®rms in this group are Time Warner, Occidental Petroleum,
Westinghouse Electric, Union Carbide, Union Texas Petroleum, Sears Roebuck, Motorola and
Inland Steel to name a few.
18
See Forster and Viswanathan (1993).
19
See also Christie and Huang (1993) and Foerster and Karolyi (1998a).
1500
L. Ramchand, P. Sethapakdi / Journal of Banking & Finance 24 (2000) 1491±1513
Table 2
Changes in stock price volatility and trading volume: Comparison between global and domestic
oers ± 1986±1993a
Variable
Global oers
Pre-oer
period
Postoer
period
Domestic oers
Ratio/
dierence
(p-value)
Pre-oer
period
Postoer
period
Ratio/
dierence
(p-value)
Panel A ± NYSE/AMEX ®rms
Standard
0.023
0.021
deviation
0.014
0.015
Trading
0.346
0.415
volume
0.391
0.374
1.095
(0.31)
20%
(