The Role of Investor Attention in Seasoned Equity Offerings

Many studies of seasoned equity offerings (SEOs) have attempted to explain the decline of a company’s stock price after it announces an SEO (see, e.g., Asquith and Mullins (1986) or Masulis and Korwar (1986)). The literature has focused on the asymmetric information about a firm in the equity market as the main explanation. Further, in models such as Myers and Majluf (1984), a crucial assumption is that all investors pay immediate attention to the equity issue announcement.

In a new paper, here, we assume instead that only some investors in the equity market pay attention to the SEO announcement, while others revise their opinions after the announcement. We then analyze the consequences of such a split between investors, a recent example of which is the seasoned equity offering of Moderna, Inc.

Moderna announced an offering of 17.6 million new shares at $76 each on May 18, 2020 after reporting earlier that day eye-catching results on its early-stage human trials for a Covid-19 vaccine. The announcement attracted the largest news search since 2008 according to Google Trends. However, there was still a significantly negative post-announcement stock return drift following a large negative SEO announcement return. Yet the company was able to use of this broad investor attention to boost its SEO valuation (i.e., the company is trading at about 218 times its estimated future sales according to Nasdaq news).

In the first part of the paper, we analyze a theoretical setting where an SEO conveys a negative signal to the equity market, but where, unlike in Myers and Majluf (1984), a fraction of investors do not pay immediate attention to the equity issue and update their opinions about the firm later. We show that, in the above setting with limited investor attention, the equity market underreacts to the SEO announcement (compared with the full attention setting). Further, we show that the announcement effect of an equity issue is increasing in investor attention (the fraction of investors paying attention to the SEO announcement). We then show that there will be a post-announcement stock return drift (driven by inattentive investors revising their opinions after the SEO announcement). Additionally, this post-announcement stock return drift will be negatively related to the extent of investor attention paid to the SEO announcement. Finally, our model implies that both the abnormal stock return upon an SEO announcement and the post-announcement stock return drift will have predictive power for the subsequent operating performance of the firm.

In the second part of our paper, we empirically test the implications of the above theory for the SEO  announcement effect and the SEO post-announcement drift. We make use of the media coverage of an SEO firm on the days before its SEO announcement as a proxy for investor attention and use data on SEOs from 2000 to 2018. We find that, first, the announcement effect of an equity issue is positively related to investor attention to the SEO announcement: i.e., while the announcement effect is negative, it is larger in magnitude for SEOs with greater investor attention. Second, the post-announcement stock return drift, while also negative, decreases with greater investor attention. Third, both the above variables (i.e., the SEO announcement effect and the post-announcement stock return drift) can predict the future operating performance of an issuing firm.

In the third part of the paper, we extend our analysis to study the relationship between investor attention and the pricing and characteristics of the SEO itself (in the U.S., the actual SEO occurs four to six weeks after the SEO announcement). We start by assuming that, to participate in an SEO, institutional investors need not only to receive information about various aspects of the firm from the SEO underwriter, but also to pay attention to this information. This last assumption is in the spirit of Merton’s (1987) investor recognition or attention model, which assumes that an investor will incorporate a security into his portfolio only if he pays attention to (or acquires information about) that security by incurring a cost. While Merton (1987) posits several possible sources of this “attention” or “recognition” cost, he views it as arising mainly from the cost of investors’ becoming aware of (or familiar with) a firm: Investors consider investing only in the stock of firms with which they have a certain level of familiarity. In a similar vein, we can assume that institutional and other investors consider investing in only the stocks of those SEO firms that they have become familiar with by incurring an “attention cost.” Then, if a larger number of institutions have paid attention to a firm’s SEO, we would expect to find a larger number of institutional investors investing in the equity of the SEO firm. Further, if the demand for the SEO firm’s equity from institutional investors is higher for SEOs receiving greater investor attention, we expect the market clearing price of the equity of such firms to be higher (for a given supply of shares offered in the SEO). We therefore expect to find a positive relationship between investor attention and SEO-firm market valuations immediately post-SEO. Additionally, if SEO underpricing is unrelated to investor attention (e.g., driven only by considerations of information extraction as argued by Benveniste and Spindt (1989)), then we expect to find a positive relationship between investor attention and firm valuation at the SEO offer price as well. If, however, SEO underpricing is itself positively related to investor attention (as implied by the theoretical SEO model of Chemmanur and Jiao (2011) or by the IPO model of Liu, Lu, Sherman, and Zhang (2019)), then the relationship between investor attention and firm valuation at the SEO offer price will be ambiguous.

We test the above hypotheses using the media coverage of a firm prior to the equity issue (i.e., after the SEO announcement but before the pricing of the SEO) as a proxy for investor attention. In particular, we find that, first, the institutional investor participation in an SEO increases as the investor attention received by the SEO firm increases. This result also holds after we control for SEO underpricing. Second, we find that the post-SEO secondary market valuation of the SEO firm also increases with investor attention. This result holds regardless of whether the market valuation proxy is constructed using the first post-SEO trading day closing price, or the stock price one quarter after the completion of the SEO. Third, we find that the underpricing of an SEO (as measured by the stock return from the SEO offer price to the closing price on the SEO issue day) is positively related to the investor attention received by the SEO firm. Fourth, we find that firm valuation at the SEO offer price is also positively related to the investor attention received by the SEO firm.

Overall, our findings shed new light on the importance of investor attention in SEOs. We analyze, theoretically and empirically, the implications of only a fraction of investors in the equity market paying immediate attention to SEO announcements and show that, (1) the SEO announcement effect is positively related to the fraction of investors paying attention to the announcement; (2) there is a post-announcement stock-return drift that is negatively related to investor attention; and (3) both the SEO announcement effect and the post-announcement stock return drift have predictive power for the subsequent operating performance of the firm. We also empirically show that investor attention has a real and positive effect on SEO characteristics such as institutional investor participation in SEOs, SEO valuation, and the post-SEO equity market valuation of issuing firms.

This post comes to us from Professor Thomas Chemmanur at the Boston College Carroll School of Management; Karen Simonyan, an associate professor of finance at Suffolk University; Yu Wang, a PhD candidate in finance at the Boston College Carroll School of Management; and Xiang Zheng, a PhD candidate in finance at the Boston College Carroll School of Management. It is based on their paper, “The Role of Investor Attention in Seasoned Equity Offerings: Theory and Evidence,” available here.

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