Long-Run Performance following Private Placements of Equity 4/23/2003 Presenters: 吳英瑋...

Long-Run Performance following Private Placements of Equity

4/23/2003

Presenters: 吳英瑋

林冠彰 (小黑 )

周中行

廖陳慶

Motive

Publicly equity issues are underwritten, registered with SEC,and sold to a large number of investor .

private equity issues are typically negotiated directly with a single or small group of investor without SEC oversight .

Announcement of public and private issues are associated with a opposite stock rice effect. While public issues are associate with positive stock price effect. Private issue are associate with negative stock price.

Motive In this study , we provide further evidence on investor

behavior and expectation around equity issue by investigating the stock price and operating performance of a sample of public traded firm conducting private equity issue .

Spiess and Affleck-Graves (1995) Loughran and Ritter (1997) They find that the stock react a negative public

announcement effect and issuing firms experience abnormally low stock return over the five years following the issue announcement.

Hypothesis

1. Investor overoptimism at time of issue announcement for the current investment or future growth and operating performance.

2. investor overweight recent experience when forming expectation.3. Manager time equity issues to take advantage of “ windows of

opportunity ”.4. Investor underreaction to information conveyed by the annoucement.5. Private placement discounts. 6. Positive stock effect.

I. Data and Research Methodology

A. Sample DescriptionB. Measurement of Long-run Abnormal

Stock-Price Performance

B.1. Buy-and-Hold Abnormal Returns

B.2. Calendar-Time Abnormal Returns

A. Sample Description (1)

* Through Dow Jones News Retrieval (DJNR) searches, we identify 952 announcements of equity private placement from the 1980 to 1996. @

* To avoid potential problem with low-price stocks, we excludes 209 firms with a price less than two dollars.@

* We also eliminate 124 firms that had completed a private placement within the preceding three years(first time is included).


The private placements in our sample are most heavily concentrated in the periods1985 to 1987 and 1991 to 1993.

firms traded on NASDAQ comprise 79 % of our sample.


Panel A of Table 1 shows that the sample spans a large numbers of industries. However some clustering is evident, with just under 55% of the sample belonging to six industry group.

To address this issue, we control for industry effects in our empirical analysis.@


Panel B of table 1 shows that the sample is skewed toward small, low book-to –market firms.

We control for size and book-to-market effects in our empirical analysis.

B. Measurement of Long-run Abnormal Stock-price Performance (1)

First. Buy-and-Hold Abnormal Return Method.

Cross-sectional dependence (Fama,1998) Second. Calendar-Time Portfolio

Approach

B.1. Buy-and-Hold Abnormal Return

The Buy-and-Hold abnormal return (BHAR) for stock i over the period from time a to time b is defined as:

Where BHRi,a;b is the buy-and-hold return of the sample firm and BHRcompi,a;b is the buy-and-hold return of the control firm over the same time period.

bacompibaibai BHRBHRBHAR ;,;,;,


The average buy-and-hold abnormal return is as :

where n is the number of firms in the sample.

n

ibaiba BHAR

nBHAR

1;,;

1


In calculating the buy-and-hold abnormal return, we consider three benchmark of post-announcement performance:

(1) a size-matched sample

(2) an industry and size-matched sample

(3) a book-to-market and size-matched sample


To assess the statistical significance of the abnormal return calculated with this method,

we utilize a bootstrapping procedure.


For each calendar month in our sample period, we form a portfolio of all samples firms that have announced a private placement in the previous three years.


We then regress the portfolio excess return on the three Fama and French factors as follows :

where Rpt is the portfolio return for month t, Rft is the risk –free interest rate, (Rmt- Rft) is the excess return on the market, SMBt is the difference in return s between a portfolio of “small” and “big”

stocks.

tthtsftmtmftpt HMLSMBRRRR


HMLt is the difference in returns between a portfolio of “high” and “low” book-to-market stocks.


We follow Mitchell and Stafford (2000) an also estimate the intercept relative to the excepted intercept. The excepted intercept is computed as the average intercept obtained from 1000 calendar-time portfolio regressions for random portfolios with the same size and book-to-market composition as the sample firm portfolio.


The test statistic is then estimated as follows :

Where is the intercept for the sample firm calendar-time portfolios, is the average intercept from 1000calendar-time portfolio regressions for the random portfolio,

se

Et

ˆˆ

E


and se is the estimated standard error of the intercept from the regression in equation (3).

We estimate the calendar-time portfolio intercept and adjusted intercept for both equal- and value-weighted portfolio.

Post-Announcement Stock Returns

•Buy-and-Hold Abnormal Returns:

No matter what the benchmark is, the long-run

abnormal performance following private equity

announcement is negative. These returns are lower than

those reported following public issues.

The sample firms even returned less than a

contemporaneous investment in Treasury bills.

•Calendar-Time Abnormal Returns:

The final results are reported in Panel B of Table 2 by

equal- and value-weighted calendar-time portfolio.

Both α and Adj α indicate the monthly abnormal

returns.

Notes: the Adj α is the difference between the event

portfolio intercept “α” and the average intercept

from 1,000 random samples of non-event firms in

the same size and book-to-market quintile of the

sample firms.

•Cross-sectional Patterns of Post-Announcement Stock-Price Performance:

Partition the sample to examine whether the long-run

underperformance is correlated with observable

characteristic and to assess the robustness of the results.

No statistically significant difference in the level of

underperformance was found across the subsamples

segmented by different characteristics.

The results are not reported in the table.

Cross-sectional Patterns (con’d)

•Firm Size:

In each quartile of firm size, the sample firms significantly underperform their benchmark.

An F-test cannot reject that the abnormal returns are equal across the size quartiles.

•Book-to-Market:

Some evidence that the magnitude of underperformance is lower for firms in the highest quartile of BV-to-MV.

An F-test cannot reject that the abnormal returns are equal across the book-to-market quartiles.


•Newly Listed Firms:

Ritter (1991) suggested that the poor long-run stock-price performance is driven by the underperformance of newly listed firms.

Take the firms for less than three years as of the event date as the newly listed.(a five year cutoff presents similar results)

An F-test cannot reject that the abnormal returns are equal across the two samples.


•Industry and Private Placement Characteristics:

An F-test cannot reject the hypothesis that the long-

run abnormal performance is equal across industries.

The level of long-run abnormal performance is no

difference between the quartiles of the fraction of shares

placed or by whether the private placement was issued at

a discount or a premium from the the market price at the

issuance.

The Underreaction Hypothesis

• The evidence of negative post-announcement abnormal

stock-price performance is inconsistent with the under-

reaction hypothesis.

• To test the underreaction hypothesis using the approach

of Kang et al. (1999).

• The results are reported in Table 3.These findings are

similar to those reported in Kang et al. for Japanese

equity issues and are not consistent with the prediction of

the specific version of the underreaction hypothesis tested.

The Underreaction Hypothesis (con’d)

• No alternative behavior theory can explain why investors would systematically react in the wrong direction to an announcement.

• The issue of why investors may have gone wrong is left for further studies.

• The negative post-announcement performance is consistent with the view that the investors are overoptimistic about the prospects of the issuing firms at the time of the private issue announcement.

• Long-run underperformance is a phenomenon associated with the issuance of equity independent of the placement method.

Ⅲ. Investor Overoptimism, Operating Performance, and Capital Expenditure

Loughran and Ritter(1997) report that the operating performance of issuing firms is better than that of a control group just prior to issue, but deteriorates afterwards.

Operating Performance around Private Placements

To gauge the operating performance of our sample firms, we compute the ratio of operating income to total assets (OIBD/assets) and the ratio of net income to total assets (ROA) for the years surrounding the private equity issues.

Operating Performance around Private Placements

Define operating income as operating income before depreciation, amortization, and taxes, plus interest income.

Why plus interest income? In sharp contrast to public issues, Table IV show

s that private equity issues tend to follow periods of relatively poor operating performance.

Operating Performance (con.)

Panel A shows that operating performance of firms issuing equity privately declines over the four-year period leading up to and including the year of issue.

And also shows that operating performance remains weak after the private equity issue.


Panel B presents industry-adjusted performance relative to the median firm in the same two digit SIC industry and shows that both OIBD/Assets and ROA for the median issuer are substantially lower than the industry median in each of the three years prior to the issue and in the year of the issue.


To provide additional evidence in the post-issue operating performance, authors following Barber and Lyon (1996) and match each sample firm to a control firm on the basis of industry.

The results further support the poor post-issue stock-price performance reflects investor disappointment about the failure to reverse the poor operating performance prior to the issue.


Loughran and Ritter (1997) report that public equity issues are preceded by a positive and significant stock-price run-ups, and that issuing firms have higher than average market-to-book ratios at the time of issuance.

- Similar to the results for public equity issues, we find high market-to-book ratios and significant stock-price run-ups prior to private equity issues..

Pre-Announcement Period Return (con.)

Why in the pre-announcement period stock-price run-ups and high market-to-book ratios ?

Pre-Announcement Period Return (con.) One possibility is that investors are anticipating a

turnaround in the performance of the firms’ existing assets in place.

Another possibility is that investors are overoptimistic about the future payoffs from the firms’ current investments and growth opportunities.

Pre-Announcement Period Return to Investors Not Participating in the Private Placement

Table V shows that over the one-year period ending one month prior to the month preceding the private placement.

- The issuing firms have a mean raw buy-and-hold return of 52.78%.

- Significantly higher than the mean contemporaneous buy-and-hold returns for the size, size and industry, and size and book-to-market control firm benchmarks.


Table IV shows that the ratio of capital and R&D expenditures to total assets (CE+RD/assets) for issuing firms is significantly higher than that of the industry median firm in the years surrounding the private placement.

We find that large capital expenditure are associated with higher pre-announcement performance, but the results are statistically weak.


Firms that issue equity privately have

-higher than average market-to-book ratio,

-positive stock-price run-ups

-post-announcement stock-price underperformance

That is similar to that found in firms making public equity offerings.

IV. Positive Announcement Effects, Private Placement Discounts, and the “Windows of Opportunity” Hypothesis

This section begins with a discussion of the implication that attempt to explain the positive stock-price reaction to private placement announcements.

Positive Announcement Effects (con.)

Wruck(1989) attributes the positive announcement effect to an improvement in the ownership structure of the firm.

--Firm value increase because the resulting increase in ownership concentration is expected to align incentives and /or the new block-holder is expected to provide value-enhancing monitoring and/or expert advice.

Positive Announcement Effects (con.)

Hertzel and Smith(1993) provide an information-signaling explanation of the value gains associated with private placement announcement.

--In a Myers and Majluf(1984) world, the firm with undervalue would decline to issue publicly, may choose to negotiate a private placement with a signal or small group of investors rather than forgo a profitable investment opportunity.

Private Placement Discounts

Earlier studies have characterized discounts as a way of providing compensation to private placement investors for expected monitoring services and expert advice, lack of liquidity, and/or the cost of due diligence.

Private Placement Discounts (con.) In our sample, the discounts are known at the

time of the issue announcement.

Thus, the obvious challenge for the information view of the discount is to explain why investors would systematically ignore the negative information in the discount.

“Windows of Opportunity” Hypothesis

The negative post-issue stock-price performance we document suggests that private placements of equity, like public equity issues, take place when investors appear willing to overpay for the firms’ equity.

“Windows of Opportunity” Hypothesis (con.)

The positive stock-price response to private placement announcements suggests that investors do not recognize the timing motivation for the case of private placements.

Private placement are sold at substantial discounts raises the question of whether managers take advantage, or are able to take advantage, of the apparent “windows of opportunity” to issue overvalue equity.

Suggest

Author suggest that a more definitive investigation of this issue will require a measure of the private placement investors’ holding periods and well-specified models of private placement discounts and the choice between public and private issue.

Summary

we find that despite having a positive stock –price reaction at annoucement, firms that issue equity privately significantly underperformance relative to the three benchmarks over the three years following the private issues. This finding is inconsistent with the underreation hypothesis.

The negative post announcement performance we documented for private issue equity, regardless of the form of the issues..

Summary

Private equity issue tend to follow periods of poor operating performance, so our evidence is not consist that investor overweight recent experience when forming expectation.

This evidence suggests that managers and investors maybe too optimistic about the investment opportunities of firm that issue equity privately.

Summary

Our evidence of post announcement underperformance raise an alternative possibility that private placement discounts reflect informed investors assessment of true (lower) firm value.

Our results are inconsistent with theories that have been advanced previously to explain the positive stock price reaction to private placement announcement.

Long-Run Performance following Private Placements of Equity 4/23/2003 Presenters: 吳英瑋...

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