4.4 Results of the Analysis
4.4.1 Sample Characteristics and Bivariate Analysis
In Table 4.1 we present descriptive statistics and pairwise differences in means between dif- ferent security types for selected characteristics that we use as proxies for market timing and the pecking-order theories of capital structure, as well as proxies for disagreement between insiders and outsiders.
4.4. Results of the Analysis 77
In Panel A we first report characteristics and differences between different issuers related to market timing. Based on the results in the table we first observe that equity issuers experience significant positive excess stock returns prior to the issue (mean value of 19.65%). These are 18.44 percentage points higher than those for straight debt issuers (mean value of 1.22%). Similar is the case when we compare equity issuers to convertible debt issuers (20.55 percentage points higher mean excess returns) and to companies that repurchase stocks (21.46 percentage points higher mean excess return).
Companies that announce stock repurchases experience significantly negative excess re- turns prior to the announcement of the share repurchase programme (mean value of -1.80%). Quite the opposite is the case in the period following the announcement of the issue, when share repurchasing companies face a mean 8.28% excess return. In a three month period
following the announcement of the issue5 excess returns are more negative for equity issuers
(mean value of -3.2%) than for straight debt issuers (mean value of 0.05%), but the difference is marginally significant. On the other hand convertible bond issuers experience significant positive excess returns (mean value of 1.61%). We present all these results in Figure 4.1.
When we look at the differences in market-to-book (MB) values, we observe companies that repurchase shares to have the lowest MB values (1.4251), while equity issuers have the highest MB values (mean MB value of 3.3262). The difference in MB values between equity issuers and issuers of debt-like securities (straight debt, convertible debt and share repurchases) is statistically significant.
Moreover, announcement period abnormal returns show that equity issuers on average experience 2.10 percentage points lower abnormal returns than straight debt issuers. Compa- nies that announce share repurchase programs experience on average 3.37 percentage points higher abnormal returns than equity issuers. The results are consistent with previous litera-
ture on the wealth effects associated with the announcement of different security issues6, with
the exception that convertible bond issuers experience 1.20 percentage points more negative excess returns around the announcement of the issue than equity issuers. It appears from Figure 1 that companies choose to issue equity after a period of stock price run-up, which is then followed by a decline of the equal magnitude. The opposite seems to be the case for share repurchases, where companies engage in them after a prolonged period of stock underperformance (compared to the market).
5Note that we treat announcement date returns separately, as we want to capture post-announcement
excess returns.
6Seasoned equity offerings induce the strongest negative wealth effects (see for example Masulis and
Korwar, 1986, Mikkelson and Partch, 1986 and Asquith and Mullins, 1986) of between -2.5 and -4.5 percent for the U.S. market, while straight debt issues induce only slightly negative wealth effects (see for example Dann and Mikkelson, 1984 and Eckbo, 1986). Convertible debt offerings induce announcement date valuation responses that are between those for equity and straight debt (see for example also Lewis, Rogalski and Seward, 2003 and Arshanpalli, Fabozzi, Switzer and Gosselin, 2004).
All this evidence is consistent with previous literature on market timing (see for example Baker and Wurgler, 2002) where equity issuers time the market and issue equity after a period of positive returns and / or before a period of declining stock returns relative to
the market. This confirms H1. Fama and French (2005) argue that firms repurchase shares
(retire equity) when leverage is low and / or investment opportunities lower the value of debt capacity (low Q). In our sample (see Table 4.1) we observe that companies that repurchase shares have the lowest Q ratio (mean value of 1.4251) and a low leverage comparable to equity issuers (mean value of 0.1798). This is in line with the findings of Fama and French.
Next, we look at the variables related to thepecking-order explanation of capital structure
(Panel B of Table 4.1). First, we observe that leverage significantly differs across different types of issuers. A significantly higher leverage for straight debt issuers (mean value of 0.2891) compared to equity issuers (mean value of 0.1716) is surprising and counterintuitive. One does expect that firms with higher leverage do not have sufficient debt capacity to issue debt. However, it is also true that other characteristics of the companies determine borrowing capacity as well (profitability, collateralibility of assets, etc.). On the other hand, equity issuers do have on average significantly lower (negative) cash flows (mean value of -2.80% of assets) compared to straight debt issuers (9.79%) and stock repurchasers (9.90%). Equity issuers on average also pay less cash dividends (1.01% of total assets) than straight debt issuers (2.13%) and convertible debt issuers in particular (3.73%). Somewhat surprising is the finding that equity issuers on average tend to keep significantly more cash and equivalents on their balance sheets (mean value of 15.95% of total assets) than straight debt issuers (5.08%). These results are somewhat difficult to reconcile with pecking-order theory of capital structure (and our Hypothesis 2) if looked upon individually. Financially constrained firms (potential equity issuers) are expected to have higher leverage, low cash flows, low dividend payments and low balances of slack on their balance sheets. In order to assess the financial constraint better we look into a comprehensive measure of financial constraint, the four-variable Kaplan-Zingales index (see equation 4.1). Furthermore and contrary to the expectations, the results for the index itself (variable KZ) do not show equity issuers to be more financially constrained than straight debt issuers. Even contrary, straight debt issuers seem to be marginally more financially constrained than equity issuers (difference in means of 0.1412). Equity issuers are significantly more financially constrained only compared to convertible bond issuers (difference of 0.6787). In addition, we compute an industry
demeaned KZ index (KZind)7 to account for uneven distribution of security types across
different industries. The results are comparable to the ones obtained using the “raw” index
measure. This evidence gives no support to the pecking-order explanation of the capital
structure (Hypothesis 2), that is that firms issue equity when they are financially (equity) constrained. The only piece of evidence consistent with pecking-order theory is the fact that
4.4. Results of the Analysis 79
equity issuers are significantly smaller firms compared to straight debt issuers (difference in log total assets of 3.50) or firms that repurchase shares (difference of 1.13).
We use several proxies to measureagreement between insiders and outsiders of the firm.
The results for these proxies are shown in Panel C of Table 4.1. First, we assume that higher dispersion (absolute value of coefficient of variation of forecasted earnings) implies higher asymmetry (disagreement) of information between investors (outsiders) and insiders. It is therefore not surprising to see that equity issuers seem to suffer more from this phenomenon (mean DISP of 0.4087) than debt issuers (mean DISP of 0.1178). Secondly, we look at the
values of the α measure. According to Dittmar and Thakor (2007) high values of α show
higher agreement between insiders and outsiders. Our results show no significant differences
inαbetween issuers of different securities. We therefore find no support for the Dittmar and
Thakor explanation (Hypothesis 3) that companies issue equity when agreement between insiders and outsiders is high (high alpha), regardless of firm valuation (market timing). In addition, we compute the measure of the volatility of the firm’s stock returns relative to the market volatility (RVOL) and find that equity issuers have significantly higher volatility of stock returns (4.2744) than straight debt issuers (1.7419), convertible debt issuer (2.2554) and share repurchasers (3.0471). The results overall indicate that there is more disagreement (higher dispersion of analysts’ forecasts) in the case of equity issuers compared to straight
debt issuers. This is in contrast to H3.
In Panel D of Table 4.1 we additionally present some other characteristics of the issues and issuers. Results show that more analysts cover debt issuers (median value of 10) than equity issuers (median of 4). This is also not surprising if we look at the size of the companies that issue straight debt and those that issue equity. The average issue size of the straight debt is around 154 million CAD, while the one of equity is around a third of that (57 million CAD). The average size of the share repurchase is around 45 million CAD. Finally, the relative issue size of equity represents on average around 27% of the assets of the issuing company at the time of the issue, but only around 4% in the case of straight debt issuers. Given the costs of issuing securities and significant difference in the sizes of different issuers, this is not surprising. Small equity issuers seem to issue larger shares of the new equity compared to their size.