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Do corporate governance attributes affect adverse selection costs? Evidence from seasoned equity offerings

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Abstract

We examine the relation between corporate governance attributes and perceived information asymmetry. In a sample of seasoned equity offerings between 1996 and 2001, we find that board independence, size of the audit committee, and officer and director ownership mitigate the negative effect of the equity offering announcement on share prices. These results are consistent with the notion that investors perceive certain governance systems to better align manager and shareholder incentives, which improves firm access to capital markets.

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Notes

  1. Using a dummy variable, we also examine the third definition of a majority of independent members (50%) on the board and audit committee, and find it to be insignificant.

  2. We obtain similar results when we use the original Jones model (Jones 1991) and whether we run both models with or without a separate intercept term (Kothari et al. 2005). We define total accruals (TA) as the difference between earnings from continuing operations and cash flow from operations. We estimate the following model quarterly using all firm-quarter observations in the same 2-digit SIC code as the offering firm. \( {\text{TA}}_{{{\text{i,t}}}} = \beta _{1} (1/{\text{A}}_{{{\text{i,t}} - {\text{1}}}} ) + \beta _{2} ((\Delta {\text{Sales Revenue}}_{{{\text{i,t}}}} - \Delta {\text{Receivables)/A}}_{{{\text{i,t}} - 1}} ) + \beta _{3} ({\text{Net Property,\ Plant \& Equipment}}_{{{\text{i,t}}}} /{\text{A}}_{{{\text{i,t}} - 1}} ) + {\text{e}}_{{{\text{i,t}}}} . \) To get reliable estimates, we require a minimum of 20 observations for each firm-quarter regression. We also exclude extreme observations with studentized residuals \( \ge {\left| 2 \right|} \) or Cook’s D statistic \( \ge {\left| 1 \right|}.\) The estimates from the firm-quarter regressions (\( \hat{\beta }_{1}, \) \( \hat{\beta }_{2} \) and \( \hat{\beta }_{3} \)) along with actual financial information for the offering firm in the four quarters preceding the offering date are then inserted in the modified Jones model to compute expected accruals (EA):

    $$ {\text{EA}}_{{{\text{i,t}}}} = \hat{\beta }_{1} (1/{\text{A}}_{{{\text{i,t}} - {\text{1}}}} ) + \hat{\beta }_{2} ((\Delta {\text{Sales Revenue}}_{{{\text{i,t}}}} - \Delta {\text{Receivables)/A}}_{{{\text{i,t}} - 1}} ) + \hat{\beta }_{3} ({\text{Net Property, Plant \& Equipment}}_{{{\text{i,t}}}} /{\text{A}}_{{{\text{i,t}} - 1}}). $$

  3. To obtain matched percentile groups, we rank all firms in a given year by their level of earnings lagged by total assets and then assign them to percentiles based on their ordered rank.

  4. Mean abnormal returns on the day preceding the SEO announcement were insignificantly different than zero, consistent with no pre-event leakage of information.

  5. Following Klein (2002 b), we included CEO ownership in lieu of officer and director holdings and found it to be insignificant.

  6. Given the significant association between OD_Own and Iss_Sz, in unreported sensitivity analysis we ran two regression models, each including only one of the two variables. OD_Own (Iss_Sz) continues to be insignificant (significant) in the presence of Abn_Acc.

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Acknowledgments

The authors would like to thank Donna Paul, Swami Kalpathy, Barbara Grein, Nikos Vafeas, Irene Karamanou and seminar participants at the University of Cyprus and the 2005 Northeast Business and Economics Association meeting for helpful comments and discussion. We are also grateful to the editor, Cheng F. Lee, and an anonymous referee whose comments have greatly improved the paper. All remaining errors are our own.

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Authors and Affiliations

  1. Washington State University Vancouver, 14204 NE Salmon Creek Avenue, Vancouver, WA, 98686-9600, USA

    John R. Becker-Blease

  2. Whittemore School of Business and Economics, University of New Hampshire, 24 College Road, Durham, NH, 03824, USA

    Afshad J. Irani

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Correspondence to John R. Becker-Blease.

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Becker-Blease, J.R., Irani, A.J. Do corporate governance attributes affect adverse selection costs? Evidence from seasoned equity offerings. Rev Quant Finan Acc 30, 281–296 (2008). https://doi.org/10.1007/s11156-007-0051-x

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