Raising Capital: Theory and Evidence by

The article really focuses on two main questions: first, how do financial markets (mostly stock prices) react to announcements of the sale of securities? The second question focuses more on the different methods used to market corporate securities. The author first looks at stock price reaction to announcements of securities sales. The author found that regardless of any security issued, the abnormal stock returns were never significantly positive. In fact, they were negative eight out of nine cases. Another point was that, on average and for all types of securities sold, stock returns for utilities was higher than that of industrials. Also, common stock offerings generate a more negative response than the issuance of debt, and convertible bonds produce a more negative response than straight issues – or debt issues.

The author then dives in to try and explain these findings. First, he looks at EPS (earnings / # shares) dilution. After a stock has been issues, more shares are outstanding, and so earnings are spread over a large number of shares – hence the lower EPS. Smith makes two assumptions here: 1. The money generated by the stock issue don’t produce enough earnings to compensate. 2. Marginal investors take financial statements at face value, and don’t really take a minute to consider what the numbers actually mean. There are some problems with these assumptions. First, if the issuance of stock doesn’t generate enough funds, then maybe managers are taking negative NPV projects and shouldn’t have issued stock. This is probable, but not consistent enough to produce the evident results that a firm’s stock price usually drops after the announcement of a stock issue. The second assumption is more difficult to defend, because marginal investors do tend to focus on the meaning of the numbers. In conclusion, EPS dilution doesn’t provide a full explanation.

The second possible explanation is price pressure. After the sale of the stock, there’s a larger supply of...