EQUITY ISSUANCE AND ADVERSE SELECTION - A DIRECT TEST USING CONDITIONAL STOCK OFFERS

We conduct a unique test of adverse selection in the equity issuance p rocess. While common stock is the dominant means of payment in bank me rgers, stock acquisition agreements provide target shareholders with v arying degrees of protection against adverse price movements in the bi dder's stock between the time of the merger agreement and the time of merger completion. We show that it is the degree of protection against adverse price changes and not the percent of stock offered in a bank merger that explains bidder merger announcement abnormal returns. This result is difficult to explain outside of an adverse selection framew ork.