J. Barry Lin

Pre-Issue Investor Optimism and Post-Issue Underperformance

Prior studies have documented long-run stock market underperformance after security offerings. Some studies conjectured that the post-issue underperformance might be the result of pre-issue investor optimism. The study reported here investigated (1) whether investor optimism is associated with post-issue underperformance, (2) how investor optimism changes in the one-year period surrounding the security-offering month, (3) whether investor optimism differs between equity issuers and debt issuers, and (4) whether such differences affect companies’ financing choices. We confirmed underperformance of debt and equity issuers and found that the post-issue buy-and-hold abnormal returns are negatively associated with pre-issue investor optimism. We found little evidence, however, that investor optimism affects companies’ financing choices. Poor post-issue performance has been well documented for both equity issuers and debt issuers. Moreover, in prior studies, the equity issuers had worse performance than the debt issuers. These effects have been attributed to investor overoptimism—perhaps, combined with corporate managers’ opportunism in taking advantage of investor overoptimism by issuing overpriced securities. No prior studies have directly tested the relationship, however, between pre-issue investor optimism and post-issue stock market performance after seasoned equity offerings and straight-debt offerings. To fill this gap, we report an examination of (1) whether investor optimism is associated with post-issue underperformance, (2) how investor optimism changes in the one-year period surrounding the security-offering month, (3) whether investor optimism differs between equity issuers and debt issuers, and (4) whether such differences affect companies’ financing choices. Assuming that financial analysts’ opinions represent those of investors, to measure investor optimism, we used analyst forecast errors (defined as the mean annual Thomson I/B/E/S consensus EPS forecast minus the actual annual EPS divided by the absolute value of the mean annual consensus EPS), the I/B/E/S consensus analyst forecasts for long-term earnings growth rates, a recommendation revision ratio (that is, the ratio of the number of analysts making upward revisions to their EPS forecasts to the number making downward revisions to their forecasts), and an “investor optimism index.” This index is the equally weighted average of the rank of analyst forecast error, the forecast of long-term EPS growth rates, and the recommendation revision ratio; it has values ranging from 0 to 1. A larger value of the investor optimism index indicates that investors were more optimistic. We applied these measures to seasoned issuers of equity and issuers of straight debt in the 1984–2002 period and found the following: (1) Before the securities were issued, investors appear to have been more optimistic about equity issuers than about debt issuers; we found a score on the pre-issue mean investor optimism index of 0.535 for equity issuers and 0.456 for debt issuers. (2) Somewhat surprisingly, after issue, although the investor optimism index dropped for debt issues (from 0.456 to 0.451), it increased for equity issuers (from 0.535 to 0.573), indicating a continuation of investor optimism about equity issuers; we found both of these changes to be statistically significant at the 1 percent level. (3) For both equity and straight-debt issuers, the post-issue buy-and-hold abnormal returns were negatively associated with pre-issue investor optimism. And this relationship was more negative and statistically more significant for equity issuers than for debt issuers. For example, the results in multiple regressions showed that, after we held other variables constant, for equity offerings, a 1 percent increase in investor optimism was significantly related to a 1.30 percent decrease in the three-year buy-and-hold abnormal return. For straight-debt offerings, however, a 1 percent increase in investor optimism resulted in only a 0.18 percent decrease in the three-year buy-and-hold abnormal return; this impact was statistically insignificant. (4) We found little evidence that investor optimism affects companies’ financing choices. (5) Finally, although multiple issuers have better performance than single issuers, the sequence of the issuance was found to be negatively related to post-issue performance. These findings provide fresh insights into the new-issue process as related to investor sentiments. The results have important implications for both the investment public and the analyst community. For example, the conventional wisdom is that managers’ attempts to sell overpriced equity may be used as a signal for short selling. Our results do not support such a trading strategy. To the contrary, our finding that the post-issue underperformance is positively associated with pre-issue investor optimism may be used as a signal in a strategy of selecting stocks with high pre-issue investor optimism for short selling.

Director Affiliations and Shareholder Wealth during the Announcement of Acquisitions

Expanding on earlier findings that outside director characteristics are significant factors on firm performance, this paper focuses on the significance of their leadership role and affiliations. Examining market reaction to acquisitions, we find acquirers with busy outside directors holding a CEO title in S and P 500 firms or holding diversified directorships obtain higher cumulative abnormal returns during the announcement date than firms with other busy outside directors. While multiple directorships could lead to ineffective monitoring, our finding highlights the potential advantage of certain busy outside directors. Large firm leadership position and diverse experiences appear to be associated with significant positive impact. Key words: Board of directors, Multiple directorships, Mergers and acquisitions

INTERPLAY AMONG THE LARGE INVESTOR GROUPS AND THE OWNERSHIP-PERFORMANCE RELATIONSHIP

This paper applies several methodologies to examine the interplay among large shareholders. We find that firm performance is positively associated with insider and institutional ownership, but negatively associated with blockholder ownership. More importantly, we find that insider and institutional ownership are negatively related to each other, functioning as substitutes. However, they are both positively related to blockholder ownership, indicating that the endogenous optimal ownership requires higher insider and/or institutional ownership when there is high blockholder ownership. Methodologically, we find that using residual ownership reduces or eliminates spurious variations in the non-linear relationship between firm performance and insider ownership, and industry adjustment generates more reliable estimates. This paper sheds light on the complex interplay among these various types of large investors.

TAX-RELATED POLITICAL COSTS AND INCENTIVES TO VOLUNTARILY EXPENSE STOCK OPTIONS AN ANALYSIS OF THE REGULATORY LANDSCAPE

The threat of regulation is clear when proposed legislation is introduced in Congress or when other regulatory bodies formally begin consideration of new, tighter requirements. When faced with proposed undesirable regulation, firms may attempt to deflect it in a variety of ways. Accounting and economics research suggests that firms use accounting policy choice as a means of reducing political costs. Prior to 2002, only two firms voluntarily expensed stock options under the provisions of FASB 123. By the end of 2003, a number of firms volunteered to expense stock options in the face of possible mandates from the FASB. A close examination of the record of regulators’ activities indicates that, during 2002 and 2003, Congress proposed five pieces of legislation that would increase the tax costs of firms and six pieces of legislation that would increase the taxes of firm managers. We suggest that the decision to begin expensing options reflects firms’ and managers’ beliefs that the voluntary expensing of stock options for financial reporting purposes would ward off regulatory efforts to convert proposed tax legislation affecting the firms’ and managers’ taxes into enacted tax law. Our preliminary analysis provides evidence consistent with this general hypothesis. While prior research on the impact of taxes on accounting policy choice has examined accounting policy choice in response to enacted tax legislation, this paper provides early evidence on accounting policy choice in the face of proposed tax legislation.