WEALTH EFFECTS OF CORPORATE-DEBT ISSUES - THE IMPACT OF ISSUER MOTIVATIONS

Firms issue securities for a variety of reasons, and both market pract ice and finance theory predict that the market's reaction to disclosur e of the intent to issue new securities depends on the motivation unde rlying the issue and whether the motivation was already known to the m arket. This study investigates whether market reactions to firms' new debt issues differ depending on the motivation for the issue. In fact, prior studies, which generally have ignored the motivation of the iss uer, have been unable to document economically or statistically signif icant market reactions to new public debt issues. We find that market reactions to new bond issues seem to be limited to those occasions whe re the motivation for the issue is to finance a cash flow shortfall, a nd the reaction is negative. This is consistent with the arguments set forth most directly by Miller and Rock. These results have practical implications for firm financial structure choices and for the investme nt banking process. In particular, the market seems to be able to infe r the underlying reason for the need to issue securities. There is no concrete evidence of negative market reactions on outstanding debt or equity for firms using new debt offerings to fund capital investments, to change leverage, or to fund maturing debt, unless the firm also is attempting to fund unexpected cash flow shortfalls. Alternatively, on ly firms that are experiencing cash flow shortfalls need to be concern ed that the new issues of debt will be accompanied by negative price r eaction in response to information about the shortfall. We sort firms into categories that are constructed to summarize the nature of the un expected motivation(s) and examine for differential market price respo nses in the different categories. With this categorization we are able to (imperfectly) characterize any new information that may be conveye d to the marketplace when the new issue details are announced. Essenti ally, these classifications provide a means for determining whether ne w information is conveyed through the announcement of the pending offe ring giving consideration to the fact that under some circumstances a new issue may convey good news, while in other situations bad news may be conveyed. Four motivation categories are defined according to whet her the debt is issued to cover an unexpected cash flow shortfall, to finance unexpected investments in capital assets, to increase the leve l of debt financing used by the firm, and/or to refinance expected lev els of existing debt coming due. This categorization was developed to correspond to existing theories that speak to the issue of unexpected price responses to financial structure changes. The most notable theor ies we examine include Miller and Rock's and Myers and Majluf's work o n asymmetric information regarding the value of assets in place, tax e ffects associated with the shelter accorded debt financing, incentive signaling, and agency costs of debt. Approximately 400 new long-term c orporate debt issues are studied, and market price responses for nearl y 1,000 outstanding equity and debt securities are examined in the wee ks surrounding the new issue filing. Risk- and market-adjusted measure s of performance are used to assess the markets reaction. Standard abn ormal returns techniques are employed to measure equity reactions. For bonds, adjustments to raw bond returns are made by subtracting an equ ivalent maturity Treasury return and, where sufficient data exists, by subtracting an estimate of the individual bond's risk premium. Our ov erall sample showed statistically insignificant negative returns of le ss than -0.2% for stocks and near-zero returns for bonds. Results were substantially and statistically different, however, according to the motivation for the issue. In particular, firms believed to be experien cing a cash flow shortfall in the quarter surrounding the new issue (w ho may have had other motivations as well) experienced abnormal return s of - 0.65% on equity and -0.4% on outstanding debt. In contrast, fir ms not experiencing cash flow shortfalls had announcement period abnor mal stock and bond returns that were about 0.75% higher. In addition, firms with other motivations that were also motivated by a cash flow s hortfall had abnormal stock returns that were about 1% lower than firm s with the same motivation that did not seem to be experiencing cash f low shortfalls. Comparable results are found for the reaction of outst anding bonds. No important market reactions were observed for refinanc ing, capital expenditure, or change in leverage motivations either alo ne or in concert with one another.