The Evolution of Equity Financing: A Comparison of Dual-Class and Single-Class SEOs Scott B. Smart and Chad J. Zutter * January 2002 Abstract This paper compares the SEO activity of young dual- and single-class firms. Because they hold stock with superior voting rights, dual-class insiders weigh different costs and benefits when issuing equity. Most importantly, the marginal dilution of voting power resulting from an SEO is lower in dual-class firms. This suggests that dual-class firms may issue equity more frequently, or under a different set of circumstances than singles. We find that dual-class firms are more likely to issue equity in the first three post IPO years. Moreover, returns prior to SEO announcements are smaller for dual-class firms, suggesting that the threshold at which SEO benefits outweigh costs is lower for these firms. Overall, SEO announcement returns are similar for both firm types, although the market penalty for issuing secondary rather than primary shares in an SEO is greater for singles than for duals. We interpret this finding as evidence that single-class issuers signal more severe overvaluation when they sell their own shares in an SEO compared to dual-class insiders. JEL classifications: G24; G32; G34 Keywords: Seasoned equity offerings (SEOs); Announcement Effects; Dual class; Reduced monitoring; Governance * Scott B. Smart, Finance Department, Kelley School of Business, Indiana University, 1309 E. 10 th St., Bloomington IN 47405, email ssmart@indiana.edu, and phone 812-855-3401. Chad J. Zutter, Finance and Economics, Katz Graduate School of Business, University of Pittsburgh, 320 Mervis Hall, Pittsburgh PA 15260, email czutter@katz.pitt.edu, and phone 412-648-2159.
The Evolution of Equity Financing: A Comparison of Dual-Class and Single-Class SEOs 1. Introduction In this paper we examine both the decision to conduct a seasoned equity offering (SEO) and the market s reaction to that decision using a sample of young firms. The primary innovation of our paper emerges from its comparison of the SEO activity of single- and dual-class firms. The typical dual-class firm deviates from the standard oneshare one-vote rule by issuing a special class of stock that conveys superior voting rights to insiders. The resulting division between dual-class insiders voting rights and cash flow claims creates the potential for severe agency problems and alters (relative to the one-share, one-vote norm) the cost-benefit equation faced by insiders weighing the SEO decision. The goal of this paper is to measure differences in the propensity with which dual- and single-class firms conduct SEOs, to highlight differences in the circumstances which lead each type of firm to conduct SEOs, and to assess the market s reaction to SEO announcements made by each type of firm. We argue that the observed differences in SEO behavior between dual- and single-class firms sheds new light on alternative theories of the SEO decision. Dozens of research studies document one of the most robust empirical findings in corporate finance the market greets leverage-increasing announcements favorably and leverage-decreasing announcements unfavorably. A strain of literature that focuses on SEOs reveals short-term announcement effects between 2.5% and 3.5%. 1 The literature 1 See for example Asquith and Mullins (1986), Kolodny and Suhler (1985), Masulis and Korwar (1986), Mikkelson and Partch (1986), and Schipper and Smith (1986). Page 2
offers several explanations for the decision to conduct an SEO and the market s subsequent reaction. Signaling theories suggest that corporate insiders choose to issue stock when they have private information that their firms are overvalued. The market interprets this and reacts negatively to SEO announcements. Agency theories argue that SEOs contribute to the misalignment of shareholder and manager interests, so the negative stock price reaction to SEO announcements reflects higher expected agency costs. Finally, a third line of argument says that stock prices decline when firms issue equity due to price pressure effects. The price pressure theory s main prediction is that the drop in stock prices is greater the larger the SEO. Predictions of the price pressure hypothesis are the same whether the issuer is a dual- or a single-class firm, but signaling and agency theories lead us to expect different outcomes for different types of firms. Consider an entrepreneur/manager with private information that the price of her firm s stock is too high. This manager must weigh any benefit from issuing overvalued equity against, among other things, the cost of diluting her voting position (assuming that the manager does not purchase a pro rata share in the SEO) and facing more intense pressure from the corporate control market. The rate at which an SEO dilutes voting power is much faster for a single-class entrepreneur. Dual-class insiders hold shares that typically have 10 times the voting power of ordinary stock; consequently, issuing new shares reduces the percentage of votes controlled by dual-class insiders at a rate which is about one-tenth the rate faced by single-class insiders conducting SEOs. This implies that, holding other factors constant, single-class insiders face higher costs and signal more severe overvaluation when they conduct SEOs than do dual-class firms. Thus, the Page 3
market should react more negatively to SEO announcements of single-class firms, and single-class firms should be less likely to conduct SEOs relative to dual-class firms. Agency models predict a negative stock price reaction for SEOs even in the absence of pricing errors. These models predict a more severe response the greater the misalignment between manager and shareholders interests. In a single-class firm, an SEO reduces the proportion of votes controlled by insiders and their cash flow claims at the same rate. In contrast, when dual-class firms issue shares, the rate at which the proportion of insiders cash flow claims decline is much faster than the rate at which the proportion of votes controlled by insiders declines. In other words, as firms issue new shares over time, the division between voting power and cash flow claims increases much more rapidly in dual-class firms. To the extent that SEO announcement effects reflect increases in expected agency costs, then we would expect the market to respond more negatively to dual-class SEO decisions. Consistent with the prediction that dual-class firms face lower costs when conducting SEOs, we find that the probability of doing an SEO within five years of the IPO is significantly higher for duals. We also find lower pre-seo stock returns for duals, suggesting that dual-class insiders are willing to incur the costs of issuing new shares to capture a smaller overvaluation benefit compared to single-class firms. However, we do not find the expected difference in the market s response to dual- and single-class SEO announcements. On average, the market s response to SEO announcements does not vary significantly with regard to the firm s equity structure. We also examine cross-sectional variation in SEO announcement returns and find an interesting pattern. For single-class SEOs, the market s response is much more negative Page 4
when the SEO consists mostly of secondary shares, i.e., shares sold by existing shareholders (usually insiders) compared to cases in which firms offer mostly primary (i.e., new) shares. In contrast, the market s reaction to dual-class SEOs is essentially the same regardless of whether the SEO consists of secondary or primary shares. We argue that this evidence is also consistent with the signaling explanation described above. When single-class insiders sell their own shares in an SEO, they dilute their voting control more rapidly and signal greater overvaluation. When dual-class insiders sell their own (ordinary) shares, the dilution in voting control they experience is negligible because they still control the shares with superior voting rights. For a dual-class insider, the marginal cost, in terms of voting power lost, of selling secondary shares in an SEO is not meaningfully different from the costs of selling primary shares. Thus, for dual-class firms, the market does not interpret a secondary-share SEO in a more negative light than a primary-share SEO. 2. Explanations for SEO Return Patterns The literature advances several theories to explain why stock prices typically fall in response to SEO announcements. Generally, these theories can be grouped into three categories: signaling, agency, and price pressure. All of these theories predict a negative price response to SEOs, but they differ in other respects. Myers and Majluf (1984) and Miller and Rock (1985) present signaling models in which managers issue new equity when their private information suggests that the market overvalues the firm s securities. Both models predict negative SEO announcement effects, while only Myers and Majluf offer the additional prediction of more negative returns for new equity issues compared to new debt. Leland and Pyle (1977) argue that Page 5
entrepreneurs signal the value of their enterprises to outside investors by holding a large fraction of equity. As entrepreneurs divest via SEOs, the stock price should drop. Another type of signaling model offering the same prediction relies on optimal capital structure arguments. A simple version suggests that if firms choose their capital structure to trade off the tax benefits of debt against expected bankruptcy costs, then in the absence of changes in these factors, equity issues signal that managers expect a reduction in future cash flows. 2 A similar argument can be made relying on the firm s sources and uses of funds constraint. Investors interpret equity issues as a signal of a decline in internal sources of funds and reprice the firm accordingly. Jensen and Meckling (1976) focus on agency problems. They argue that as managers equity holdings decline, the interests of managers and shareholders become misaligned. For example, if managers consume excessive perquisites, they enjoy the entire benefit of that consumption, but suffer a cost equal only to their fractional ownership. 3 The smaller the fraction of equity held by management, the more severe these problems become. The price pressure hypothesis asserts that demand curves for shares slope downward. When firms bring new shares to the market, a temporary price reduction occurs until the market absorbs the new issue. The price pressure hypothesis also predicts that SEO announcement returns will be more negative for larger issues. The results of various empirical studies offer support for both agency and signaling models. Mikkelson and Partch (1986) find that new-issue announcement effects depend 2 See Modigliani and Miller (1963), Masulis (1980a and b, 1983), and DeAngelo and Masulis (1980). 3 Here and throughout the paper we use the term perquisite consumption as a generic term to describe actions that managers take in their own interest rather than acting on the behalf of shareholders. Page 6
almost exclusively on the type of security being issued as predicted by Myers and Majluf. Asquith and Mullins (1986) report that the loss in value following an SEO announcement equals nearly one-third of the money raised in the SEO. The tow previous papers, as well as Slovin et al (1994), find that significant abnormal stock-price gains precede SEO announcements. One interpretation of this pre-announcement runup is that managers issue shares when they believe their firm is overvalued. Loughran and Ritter (1995, 1997) find that both stock returns and measures of operating performance decline for several years after SEOs. Asquith and Mullins (1986) and Kraus and Stoll (1972) report a negative correlation between SEO size and announcement returns, consistent with the price pressure hypothesis. However, Scholes (1972) and Mikkelson and Partch (1986) dispute this finding. The goal of this paper is to shed new light on the price effects of SEOs as well as the factors that influence managers to issue new equity by comparing SEOs conducted by dual- and single-class firms. The dramatic differences in governance structures between these two groups of firms help distinguish between alternative explanations for the empirical evidence. We focus on SEOs conducted by relatively young firms, those that went public via an IPO from 1990-1998. In the 1980s, several firms adopted dual-class shares as a means to deter takeovers. However, it was not until the 1990s that goingpublic firms began to adopt dual-class equity in large numbers. It is because so many dual-class firms emerged recently that we restrict our analysis of SEOs to firms that went public in the 1990s. Before describing out empirical tests, we describe the data used in this study and present descriptive statistics for the sample. 3. Data and Descriptive Statistics Page 7
The primary data source is the Disclosure New Issues database from Disclosure, Inc., a Primark, Inc. division. The dataset resides on three compact discs (CDs), includes new issues from January 1990 through September 1998, and provides a wealth of information about debt and equity offerings on an issue-by-issue basis for any original or subsequent registration or prospectus filed with the Securities and Exchange Commission (SEC). 4 Disclosure s inclusion criterion is that a firm provides either direct goods or services to the public. Types of firms excluded from the dataset include closed-end mutual funds, investment companies, real-estate investment trusts, and limited partnerships. 5 We extract new issues from Disclosure by selecting records for firm-commitment IPOs of common stock from 1990 through 1998. The search yields 3,628 issues. Disclosure s initial CDs often contain incomplete records. Later, when data that are more complete become available, Disclosure compiles the record again on a subsequent CD. Eliminating duplicate records reduces the sample to 2,787 issues. We further eliminate issues because other data sets in the study lack matching security data resulting in 2,622 Disclosure IPOs (including 254 dual-class IPOs) with offer prices ranging from $5 to $35 per share. We use Securities Data Corporation s (SDC) New Issue Database to determine which firms conduct an SEO following their IPO. SDC tracks 2,572 (including 241 dualclass IPOs) of the 2,622 Disclosure IPOs. We obtain security returns from the Center for Research on Securities Prices (CRSP) files and financial data from COMPUSTAT tape files. We exclude one hundred thirty-nine firms that do not have return series available on 4 Because the sample ends in September 1998 it does not include many of the more spectacular firstday returns associated with Internet stocks. 5 Compared to another well-known IPO data provider, Securities Data Corp., Disclosure under samples small IPOs, though it does not entirely exclude them. Page 8
the CRSP directory from analysis that includes these data (this leaves 2,433 IPOs including 221 duals). These are generally non-listed or foreign firms. For the final sample of 2,433 IPOs we verify the occurrence of an SEO event subsequent prior to the end of 2000. Table 1 shows descriptive statistics for the full sample. Of 2,433 IPOs from 1990-1998, 42% conduct at least one SEO before January 2001. Firms that choose not to issue new equity differ from those that do on several dimensions. SEO firms receive venture backing about 50% of the time compared to 40% for non-issuers. Not surprisingly, firms carrying out SEOs earn significantly higher returns out of the gate following their IPOs than their counterparts that do not conduct SEOs. In many other respects, however, the two sets of firms closely resemble each other. Only minor differences exist in terms of firm size, underpricing, or money raised at the IPO date. Among those firms conducting SEOs, dual- and single-class firms display several differences. Dual-class firms are larger, receive less frequent venture backing, use higher quality underwriters, and list on Nasdaq less often than singles. According to Smart and Zutter (2001), each of these differences mirrors the population differences (i.e., the differences between singles and duals without regard to whether they did an SEO or not). Single-class firms raise more money relative to their market capitalization when they issue equity. The pre-announcement stock-price runup for singles exceeds that for duals, regardless of whether one measures raw or abnormal returns. 6 One interpretation of the 6 We measure abnormal returns as daily cumulative abnormal returns (CAR). τ ( ) where R t= 1 it is the simple daily return for sample firm i and E(R it ) is the day t CAR = R Ε R iτ it it Page 9
tendency of SEOs to follow abnormal positive returns is that managers issue new shares when the market overvalues the firm. Applying that interpretation here implies that the degree of overvaluation necessary to prompt a dual-class SEO falls short of that required to bring forth a single-class SEO. The remainder of this paper considers this hypothesis and others in more detail using multivariate statistics. 4. SEO Announcement Returns This section documents abnormal return patterns around dual- and single-class SEO announcements. We conjecture that signaling and agency-cost explanations of SEO announcement returns offer different predictions for dual- and single-class firms. If the price effects of SEOs reflect investors concerns about the rising potential for agency problems, the price response to a dual-class SEO should be larger than that of a singleclass announcement. The reason for this conjecture is that while SEOs lower managers ownership stakes in both types of firms, the price of perquisite consumption relative to control falls more rapidly for dual-class managers. After the IPO, most dual-class insiders hold significant positions in both ordinary A shares and B shares with superior voting rights. 7 When dual-class insiders hold both types of shares, the ratio of the proportion of votes that they control to their proportion of cash flow claims is close to 1.0. Over time, as insiders divest their A shares (or as their fractional ownership of A shares declines expected return for the sample firm. To calculate abnormal returns using a market model the day t expected return is Ε ( R ) = β R, where R mt is the simple daily return for the CRSP value-weight index. it it mt 7 When dual-class insiders sell shares in an SEO (whether their personal shares or new shares issued by their firms), they only offer A shares to the public. The corporate charter of most dual-class firms dictates that if insiders sell their B shares to outsiders, the shares lose their superior voting rights. Page 10
relative to outside shareholders ), their ratio of voting control to cash flow ownership rises dramatically. The most common dual-class configuration grants 10 votes per share to class B shares, so in the limiting case in which insiders own all of the B shares and none of the A shares, the ratio of votes controlled to cash flow claims reaches ten. In contrast, if single-class managers divest (or dilute) their holdings as part of an SEO, the votes they control decline at exactly the same rate as their cash flow claims. As Jensen and Meckling (1976) note, although a smaller cash flow claim lowers the price of perquisite consumption, a lower ownership position implies greater exposure to the market for corporate control. Therefore, as firms raise capital through SEOs, the potential for agency problems increases at a faster rate for dual-class firms. Alternatively, if SEO announcement returns reflect the market s belief that managers believe their shares to be overvalued, then the relative magnitudes of abnormal returns should reverse. That is, both dual- and single-class managers must weigh the monetary benefits of selling overvalued shares against the cost of diluting their ownership stakes via an SEO. Holding the number of shares issued constant, the loss of control faced by single-class managers exceeds that for dual-class managers. By opting for the SEO, single-class managers therefore signal a greater degree of overvaluation, on average, than dual-class firms conducting SEOs. Consequently, signaling models should predict a more negative price response for single-class SEOs. 8 8 The price pressure hypothesis predicts that the larger the SEO, the more negative the announcement effect, and holding SEO size constant, the price pressure theory makes no predictions about differences between dual- and single-class SEOs. Page 11
Before presenting the results, three caveats warrant attention. First, investors at the IPO presumably understand the potential agency problems that dual-class shares create. They may anticipate a greater propensity to conduct SEOs for duals because insiders sacrifice little control by issuing new class A shares. To the extent that the market expects dual-class managers to exploit their insulated position, we expect smaller announcement effects for dual-class SEOs (in absolute value). Second, insiders of both dual- and singleclass firms typically own large fractions of their firm s shares after the IPO. Given the size of the typical SEO, the associated ownership dilution does not necessarily imply an economically significant increase in exposure to market discipline, even for single-class managers. 9 In such a case, a signaling model would not necessarily predict more negative announcement returns for singles. Third, the signaling and agency theories are not mutually exclusive. If both operate simultaneously, their offsetting effects will cloud the interpretation of empirical results. Table 2 presents cumulative abnormal returns (CARs) for a three-day event window surrounding SEO announcements. Panel A shows CARs associated with the full sample of SEOs while Panel B shows only those abnormal returns associated with first SEOs. In both panels, the average three-day CAR falls between 2% and 2.5%, very similar to CARs reported in other studies that use data from the 1970s and 1980s. In the full sample of SEOs, the average CAR for duals falls just one basis point below the mean CAR for singles. In the sample of first SEOs, the mean single-class CAR exceeds the dual 9 Over time, insiders divest their holdings and should eventually reach a point at which a marginal reduction in ownership creates real exposure to the market for corporate control. Theory does not offer a clear prediction of where this threshold lies, but it is possible that a longer panel of data is necessary to observe firms reaching it. Page 12
abnormal return by 31 basis points. No significant difference in mean (or median) CARs emerges in either panel. Table 3 reports estimates from a cross-sectional regression analysis of three-day SEO abnormal returns. The model contains a dummy variable equal to one to capture any differences that exist between dual- and single-class SEO announcement effects. This model controls for other factors which, according to previous research, influence SEO announcement returns. Welch (1989) develops a model in which firms underprice more severely at the IPO to signal high quality. High-quality firms recoup signaling costs when conducting future SEOs. Slovin et al (1994), Jegadeesh et al (1993), and Garfinkel (1993) test Welch s model and find higher SEO returns for those firms with more severely underpriced IPOs, although the studies conclude that the underpricing costs far outweigh the subsequent SEO gains. To capture this effect, the regression model includes the IPO initial return for each firm conducting a subsequent SEO. Because more analysts follow larger firms, there should be less asymmetric information between the market and firm insiders the larger the firm. Accordingly, the regression model includes the market capitalization of each SEO firm just before the SEO announcement. In the same vein, with more time to observe a firm, investors reduce information asymmetries. The regression model includes the reciprocal of time since the firm s IPO to control for this effect. When the shares offered in an SEO come from insiders (rather than from the firm issuing new shares), Slovin et al. (1994) report a more negative share-price response. The ratio of secondary shares (i.e., shares sold by existing shareholders) to total SEO shares controls for this tendency. Asquith and Mullins (1986) report that SEO abnormal returns Page 13
increase with greater pre-seo stock-price performance, so the regression model includes each firm s CAR for the six months leading up to the SEO. Asquith and Mullins and Kraus and Stoll (1972) find a negative relationship between SEO size and abnormal returns, consistent with the price pressure hypothesis. Therefore, we include the SEO proceeds divided by the firm s market cap to control for price pressure effects. Finally, we include a dummy variable equal to one for firms listed on Nasdaq to distinguish them from NYSE/AMEX firms. Panels A and B of Table 3 analyze cross-sectional determinants of all SEO CARs and first-seo CARs respectively. In both regressions, larger firms experience higher (less negative) announcement returns, and firms with a high fraction of SEO shares offered by existing shareholders earn lower returns. In Panel A only, the pre-seo CAR positively relates to the announcement effect. Neither the dual-class dummy variable nor any of the other control variables exert significant effects on SEO abnormal returns. Though the average dual- and single-class SEO announcements generate nearly identical returns, a different pattern emerges when we examine subsamples of SEOs. Differences in announcement returns between SEOs that contain only primary (new) shares and those that contain only secondary (sold by existing shareholders) shares provide interesting insights. Consider the predictions of agency and signaling models with respect to these two groups of SEOs. Agency models predict more negative returns when insiders sell shares because the fraction of equity insiders own drops more rapidly than when the firm issues new shares. This effect should be more pronounced for duals than for singles because when dual-class insiders reduce their holdings of class A shares, the price of consuming perquisites falls, but managers voting control barely changes. Page 14
Dual-class managers enjoy the opportunity to pursue their own interests at the expense of shareholders without increasing their exposure to the market for corporate control. Conversely, while the price of consuming corporate resources falls for managers of single-class firms conducting SEOs, voting control falls at the same rate. The marginal increase in exposure to market discipline constrains the behavior of single-class managers. Therefore, agency theory suggests that the difference in SEO announcement returns between primary and secondary offerings should be greater for duals than for singles. Signaling models make the opposite prediction. Managers issue shares when they believe the market overvalues the firm. When managers sell their own shares they must weigh the benefits of selling overvalued stock against the cost of diluting their ownership stakes. Though any SEO dilutes managers ownership stakes, dilution is higher in secondary SEOs than in primary SEOs. As a result, the market should interpret that the degree of overvaluation is greater when firms conduct secondary as opposed to primary SEOs. Now consider how this logic applies to duals and singles. The control-dilution cost that single-class managers must pay is proportional to the cash benefits they receive from selling shares. For dual-class managers, the cash benefits accrue at a rate ten times greater than the rate at which their voting positions decline. In other words, the cost differential between secondary and primary SEOs is significant for single-class managers, whereas it is negligible for dual-class managers. The difference between secondary and primary SEO announcement returns for singles should be greater than the same difference for duals. Page 15
Table 4 shows evidence confirming this hypothesis. For dual-class firms, no significant difference exists between primary and secondary SEO announcement returns. For single-class firms, secondary SEO announcement returns fall below primary SEO returns by about 1.7%, a statistically and economically significant difference. 10 That the market attaches a more negative interpretation to secondary SEOs versus primary SEOs for single-class firms, but not for duals, supports the signaling hypothesis over the agency cost hypothesis. We have argued that the insulation afforded dual-class managers lowers their costs of conducting SEOs. If this is the case, then controlling for other factors that influence the decision to do an SEO, the probability of conducting an SEO should be higher for duals than for singles. The next section presents evidence consistent with this hypothesis. 5. The SEO Decision In this section, we estimate a logit model designed to assess differences in the probability that a given type of firm will conduct an SEO. Table 5 shows the distribution of SEO events over time for all SEOs (Panel A) and for single- and dual-class firms separately (Panels B and C respectively). In Panel A, note that a significant fraction of IPO firms raises new equity within three years of the IPO. In the average IPO cohort, about one-third of the firms sell shares via an SEO within the next three years. 11 Careful 10 Segmenting the sample based on a majority of secondary shares allows for larger sample sizes and finds that Table 4 results are robust. 11 Actually, this is a conservative estimate of SEO activity because we count the IPO year in the threeyear total whether a firm went public in January or December. This conservatism is evident in Panel A of Table 6 which shows a higher percentage of firms conducting SEOs within three years of going public when employing an exact measure of time since the IPO. Page 16
examination of Panels B and C reveals that, over any given post-ipo time window, a larger percentage of dual-class firms than single-class firms raise money through an SEO. For example, across all IPO cohorts about 32% of singles and 37% of duals raise new equity within three years of the IPO. Of course, duals and singles differ systematically in several respects, and any differences could be correlated with the SEO decision. Table 6 reports estimates from a logit model in which the dependent variable equals one if a firm in our sample conducts an SEO within its first three years of existence and zero otherwise. Jegadeesh et al. (1993) find that the probability that a firm conducts an SEO relates to firm size, first-day IPO returns (i.e., underpricing), and post-ipo returns. We include each of these measures in the regression model. We include a dummy variable equal to one for those firms backed by venture capital. Lin and Smith (1998) find that most venture capitalists do not liquidate their investments via the firm s IPO. Venture capitalists who do not sell their stakes at the IPO may wait for an SEO to liquidate their investments in young firms. The logit model also controls for the IPO underwriter reputation as measured by the Megginson-Weiss statistic and for exchange listing. 12 Logit estimates reveal that holding other factors constant, dual-class firms are more likely to conduct an SEO within three years of their IPO than are single-class firms. Moreover, the significance of the term interacting the dual-class dummy with post-ipo returns indicates that the effect of post-ipo returns on the probability of observing an SEO is greater for duals than singles. To interpret this result, imagine two firms with 12 Megginson and Weiss (1991) measure underwriter reputation as the fraction of total dollars raised during the sample period. Page 17
identical characteristics except that one is a single and one is a dual. For a given post-ipo return, the probability of an SEO is higher for the dual-class firm. For the single-class firm to achieve the same SEO probability, ceterus paribus, its post-ipo returns must be higher than the dual s. If the benefit that insiders reap when they sell shares in an SEO correlates positively with stock returns (as it would be if overvaluation motivates the SEO decision), then the logit results suggest that single-class managers require larger benefits than duals before they will conduct an SEO. 6. Conclusion The unique governance structure of dual-class firms provides an opportunity to examine the predictions of alternative theoretical explanations of SEOs. Agency models suggest that the market s negative reaction to SEO announcements reflects an acknowledgement that SEOs widen the difference between manager and shareholder interests. Signaling theories explain the market s reaction as a revelation that managers believe their firms to be overvalued. The price pressure hypothesis suggests that the market simply cannot absorb a significant quantity of new shares without a decline in price. Observed differences in the market s reaction to SEOs, and in the relative propensities of dual- and single-class firms to conduct SEOs, tend to support signaling theories. Though, on average the market s response to dual and single-class SEOs is virtually identical, significant differences emerge when we examine market responses to primary and secondary SEOs. Specifically, the market responds more negatively to single-class secondary offers than to single-class primary offers, but the market s reaction to dual-class offers does not vary with respect to the type of shares offered. This evidence Page 18
is more consistent with the idea that the market evaluates the cost-benefit tradeoffs that managers evaluate when carrying out SEOs than it is with the notion that the market is concerned primarily with agency problems following SEOs. The logit model suggests the same interpretation. Dual-class managers undertake SEOs more often than single-class insiders, and the runup required to prompt an SEO is smaller for duals than for singles. Both facts suggest that the costs of issuing new shares are lower for dual-class managers than for their single-class counterparts. Page 19
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Table 1 Descriptive Statistics for the Full Sample of IPOs by Offer Type This table presents descriptive statistics for the full sample of IPOs by offer type and first SEO occurrence. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. Statistics pertaining to seasoned equity offering (SEO) are for the first SEO conducted by a sample firm before 2001. IPO market capitalization is the total number of shares outstanding upon completion of the IPO times the first-day secondarymarket closing price. IPO total proceeds is the total number of shares offered times the final IPO price. IPO underpricing is the change in price from the final offer price to the first-day secondary-market closing price. Three-month post-ipo CAR and CR are the cumulative abnormal and cumulative returns respectively over the first three months following the IPO. Venture-backed deals, hi-quality underwriter deals, and Nasdaq-listed deals represent the percentage of each within the respective sub samples. SEO market capitalization is the total number of shares outstanding upon completion of the SEO times the final SEO price. SEO total proceeds is the total number of shares offered times the final SEO price. Average time till first SEO equals the elapsed years since the IPO. Secondary shares sold equals the percent of previously outstanding shares sold in the offering. SEO proceeds relative to size at SEO equals the total proceeds raised divided by the market capitalization for the SEO month. Six-month pre-seo CAR and CR are the cumulative abnormal and cumulative returns respectively over six months before the SEO. SEOs with announcement dates after their filing date are not included in analysis of SEO CARs and CRs. There are 866 (775 singles and 91 duals) SEOs with announcement dates either before or on their filing date. We adjust dollar values to constant 2000 dollars using the Consumer Price Index. P- values refer to t-tests of equal means across offer types. Mean values by offer type that are significantly different at conventional levels are in bold. Mean Values All IPOs Non SEO IPOs All First SEO IPOs Single First SEO IPOs Dual First SEO IPOs P-value Number of Deals 2,433 1,412 1,021 917 104 IPO Market Capitalization in Millions $317.219 $331.435 $297.559 $259.911 $629.509 0.0146 IPO Total Proceeds in Millions $73.330 $74.997 $71.025 $65.781 $117.261 0.0293 IPO Underpricing 13.6% 12.8% 14.8% 14.9% 13.5% 0.4193 3-month Post IPO CAR 4.3% -1.2% 11.8% 11.9% 10.8% 0.6623 3-month Post IPO CR 8.1% 2.3% 16.0% 16.2% 14.4% 0.5291 Venture-backed 44.1% 39.5% 50.3% 52.8% 28.8% 0.0001 Hi-quality Underwriter 52.1% 49.3% 56.0% 54.3% 71.2% 0.001 Nasdaq Listed 82.7% 81.8% 83.9% 84.8% 76.0% 0.0445 SEO Market Capitalization in Millions $524.190 $454.606 $1,137.730 0.0252 SEO Total Proceeds in Millions $85.730 $80.291 $133.685 0.0055 Average Time Till First SEO in Years 1.643 1.648 1.599 0.6796 Secondary Shares Sold 38.9% 38.5% 42.5% 0.3127 SEO Proceeds Relative to Size at SEO 21.4% 21.5% 19.8% 0.0861 6-month Pre SEO CAR 39.0% 39.7% 32.8% 0.1003 6-month Pre SEO CR 49.6% 50.7% 39.9% 0.0129 Page 22
Table 2 SEO Announcement Effects by Offer Type This table presents CARs for the announcement of SEOs by offer type. The full sample includes 2,433 firmcommitment initial public offerings dating from January 1990 through September 1998. SEOs are conducted by a sample firm before 2001. CAR is the cumulative abnormal return for the three days surrounding the SEO announcement date. SEOs with announcement dates after their filing date are not included in analysis of SEO CARs. All mean and median values that are significant at conventional levels are in bold. Panel A. CARs for All SEOs Full Sample of SEOs Single-class SEOs Dual-class SEOs Number of Deals 1,241 1,114 127 Mean CAR -2.26% -2.26% -2.25% Median CAR -2.53% -2.51% -2.74% Panel B. CARs for First SEOs Full Sample of SEOs Single-class SEOs Dual-class SEOs Number of Deals 866 775 91 Mean CAR -2.40% -2.43% -2.12% Median CAR -2.50% -2.49% -2.66% Page 23
Table 3 Cross-sectional Analysis of SEO Announcement Effects by Offer Type This table presents ordinary least squares regression analysis of CARs for the announcement of SEO on offer type. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. SEOs are conducted by a sample firm before 2001. The dependent value CAR is the cumulative abnormal return for the three days surrounding the SEO announcement date. SEOs with announcement dates after their filing date are not included in analysis of SEO CARs. Dual-class deal is one for dual-class SEOs and zero otherwise. IPO underpricing is the change in price from the final offer price to the first-day secondary-market closing price. SEO market capitalization is the total number of shares outstanding upon completion of the SEO times the final SEO price. Secondary shares sold equals the fraction of previously outstanding shares sold in the offering. Six-month pre-seo CAR is the cumulative abnormal return over six months before the SEO. Days since IPO equals the elapsed days since the IPO. Nasdaq-listed deals represent the percentage of each within the respective sub samples. In Panels A and B, 27 firms that conduct their first SEO prior to the their six-month IPO anniversary have truncated pre-seo CARs. We adjust dollar values to constant 2000 dollars using the S&P 500 Index. Coefficients that are significant at conventional levels are in bold. Panel A: All SEOs Parameter Estimate Standard Error P-value Intercept -0.074 0.020 0.0002 Dual-class Deal 0.000 0.006 0.9904 IPO Underpricing 0.004 0.010 0.6707 LN of SEO Market Capitalization in Millions 0.009 0.003 0.0010 SEO Proceeds Relative to Size at SEO 0.018 0.021 0.3811 Fraction of Secondary Shares Sold -0.022 0.006 0.0001 Six-month Pre-SEO CAR 0.013 0.005 0.0146 Inverse of Days Since IPO -0.303 0.977 0.7569 Nasdaq Listed -0.005 0.006 0.4272 Adjusted R-square 0.020 P-value for Prob>F 0.0001 Number of Observations 1,241 Panel B: First SEOs Parameter Estimate Standard Error P-value Intercept -0.067 0.025 0.0072 Dual-class Deal 0.002 0.007 0.8334 IPO Underpricing 0.012 0.012 0.3398 LN of Size at SEO 0.008 0.003 0.0130 SEO Proceeds Relative to Size at SEO 0.023 0.027 0.3954 Fraction of Secondary Shares Sold -0.022 0.007 0.0013 Six-month Pre-SEO CAR 0.004 0.006 0.5555 Inverse of Days Since IPO -0.619 1.119 0.5800 Nasdaq Listed -0.007 0.007 0.3353 Adjusted R-square 0.012 P-value for Prob>F 0.0207 Number of Observations 866 Page 24
Table 4 SEO Announcement Effects by Offer Type and Fraction of Secondary Shares This table presents CARs for the announcement of SEOs by offer type and fraction of secondary shares. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. SEOs are conducted by a sample firm before 2001. CAR is the cumulative abnormal return for the three days surrounding the SEO announcement date. SEOs with announcement dates after their filing date are not included in analysis of SEO CARs. Bold values reflect a significant difference in means for 0% and 100% secondary shares at conventional levels. Single-class SEOs Dual-class SEOs Mean CAR Number of SEOs Mean CAR Number of SEOs 0% Secondary Shares -1.10% 211-2.60% 18 100% Secondary Shares -2.82% 121-2.25% 22 Page 25
Table 5 First SEO Event by IPO Cohort for All Firms This table presents the cumulative percentage of firms in a given IPO cohort conducting their first SEO. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. Statistics pertaining to seasoned equity offering (SEO) are for the first SEO conducted by a sample firm before 2001. Panel A. Cumulative Percentage of Firms in a Given IPO Cohort Conducting First SEO IPO/SEO Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Total IPOs 1990 3.0% 34.3% 41.8% 49.3% 50.7% 53.7% 55.2% 58.2% 58.2% 58.2% 59.7% 67 1991 0.0% 6.9% 25.9% 39.2% 42.7% 46.6% 49.1% 50.4% 50.9% 51.7% 51.7% 232 1992 0.0% 0.0% 6.1% 31.4% 36.6% 42.7% 46.0% 47.9% 48.5% 49.4% 50.0% 328 1993 0.0% 0.0% 0.0% 5.8% 19.8% 30.4% 36.8% 41.3% 42.9% 43.7% 44.4% 378 1994 0.0% 0.0% 0.0% 0.0% 2.1% 25.2% 37.4% 40.6% 43.4% 43.4% 43.7% 286 1995 0.0% 0.0% 0.0% 0.0% 0.0% 8.4% 30.0% 37.7% 40.0% 41.6% 43.2% 310 1996 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 7.0% 25.1% 32.1% 34.5% 37.6% 455 1997 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 5.5% 19.2% 25.7% 27.7% 292 1998 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 7.1% 16.5% 21.2% 85 2,433 Page 26
Table 5 Continued First SEO Event by IPO Cohort for Singles This table presents the cumulative percentage of firms in a given IPO cohort conducting their first SEO. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. Statistics pertaining to seasoned equity offering (SEO) are for the first SEO conducted by a sample firm before 2001. Panel B. Cumulative Percentage of Firms in a Given IPO Cohort Conducting First SEO IPO/SEO Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Total IPOs 1990 3.2% 36.5% 42.9% 47.6% 49.2% 52.4% 54.0% 57.1% 57.1% 57.1% 58.7% 63 1991 0.0% 6.6% 24.9% 38.0% 41.3% 45.5% 48.4% 49.8% 49.8% 50.7% 50.7% 213 1992 0.0% 0.0% 6.1% 30.9% 36.3% 42.8% 45.7% 47.6% 48.2% 49.2% 49.8% 311 1993 0.0% 0.0% 0.0% 6.0% 20.8% 30.8% 37.3% 41.6% 43.3% 44.2% 45.0% 351 1994 0.0% 0.0% 0.0% 0.0% 2.3% 25.8% 37.3% 39.6% 41.5% 41.5% 41.9% 260 1995 0.0% 0.0% 0.0% 0.0% 0.0% 8.4% 29.6% 36.2% 38.7% 40.4% 42.2% 287 1996 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 7.3% 25.3% 31.0% 33.5% 36.3% 400 1997 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 5.9% 19.4% 24.5% 26.9% 253 1998 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 6.8% 16.2% 21.6% 74 2,212 Page 27
Table 5 Continued First SEO Event by IPO Cohort for Duals This table presents the cumulative percentage of firms in a given IPO cohort conducting their first SEO. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. Statistics pertaining to seasoned equity offering (SEO) are for the first SEO conducted by a sample firm before 2001. Panel C. Cumulative Percentage of Firms in a Given IPO Cohort Conducting First SEO IPO/SEO Year 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Total IPOs 1990 0.0% 0.0% 25.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 75.0% 4 1991 0.0% 10.5% 36.8% 52.6% 57.9% 57.9% 57.9% 57.9% 63.2% 63.2% 63.2% 19 1992 0.0% 0.0% 5.9% 41.2% 41.2% 41.2% 52.9% 52.9% 52.9% 52.9% 52.9% 17 1993 0.0% 0.0% 0.0% 3.7% 7.4% 25.9% 29.6% 37.0% 37.0% 37.0% 37.0% 27 1994 0.0% 0.0% 0.0% 0.0% 0.0% 19.2% 38.5% 50.0% 61.5% 61.5% 61.5% 26 1995 0.0% 0.0% 0.0% 0.0% 0.0% 8.7% 34.8% 56.5% 56.5% 56.5% 56.5% 23 1996 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 5.5% 23.6% 40.0% 41.8% 47.3% 55 1997 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 2.6% 17.9% 33.3% 33.3% 39 1998 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 0.0% 9.1% 18.2% 18.2% 11 221 Page 28
Table 6 Logistic Regression Analysis of SEO Events Within Three Years of the IPO on Offer Type This table presents logistic regression analysis of SEO events within three years of the IPO on offer type. The full sample includes 2,433 firm-commitment initial public offerings dating from January 1990 through September 1998. SEOs are conducted by a sample firm before 2001. The dependent is equal to one for IPOs that conduct an SEO within three-years and zero otherwise. SEOs with announcement dates after their filing date are not included in analysis of SEO CARs. IPOs after 1997 are not included. Dual-class deal is one for dual-class SEOs and zero otherwise. Three-month post-ipo CAR is the cumulative abnormal return over the first three months following the IPO. IPO market capitalization is the total number of shares outstanding upon completion of the IPO times the first-day secondary-market closing price. IPO underpricing is the change in price from the final offer price to the first-day secondary-market closing price. Venture-backed deals and Nasdaq-listed deals represent the percentage of each within the respective sub samples. Underwriter quality is the Megginson and Weiss measure equal to the underwriter s market share of total offer value of the sample. We adjust dollar values to constant 2000 dollars using the S&P 500 Index. Coefficients that are significant at conventional levels are in bold. Panel A: Percentage of First SEO Event Within Three-years by Offer Type Single-class Dual-class P-value Number of Deals With 3-years of IPO Time 2,138 210 First SEO Within 3-years of IPO Time 0.361 0.429 0.0512 Panel B: Logistic Regression of First SEO Event Within Three Years on Offer Type Parameter Estimate Standard Error P-value Intercept -2.647 0.548 0.0001 Dual-class Deal 0.307 0.174 0.0775 Three-month Post-IPO CAR 1.843 0.175 0.0001 Interaction of Dual-class Deals and Post-IPO CAR 1.419 0.708 0.0451 LN of IPO Market Capitalization in Millions 0.331 0.066 0.0001 IPO Underpricing 0.380 0.250 0.1285 Venture-backed IPO 0.375 0.098 0.0001 Underwriter Quality -1.969 1.151 0.0872 Nasdaq Listed 0.302 0.150 0.0437 Correct Predictions 68.9% Number of Observations 2,348 Page 29