A Study of Rights Issues of Equity by New Zealand Firms

Abstract

This thesis examines security price reaction to the announcement of rights issues by New Zealand listed firms over the 1976 - 1994 period. Rights issues whereby equity is offered to existing shareholders on a pro-rata basis is the most common method used by New Zealand firms to source additional equity capital. Most rights issues in New Zealand are renounceable with the subscription price for shares offered to existing shareholders being set at a discount to the current market price. Rights entitlements or the right to purchase new shares at a discount to the market price are therefore valuable. With renounceable rights offerings, existing shareholders can take-up the new shares offered under the issue or sell all or part of their rights entitlement to other investors. To explain security price reaction to the announcement of a rights issue, chapter four of this thesis develops a theoretical model under the framework of the Myers and Majluf (1984) analysis. The model allows for varying levels of participation in the issue by existing shareholders. The model illustrates that the greater the anticipated level of existing shareholder participation in the rights issue the smaller any adverse selection costs and potential for wealth transfer from old to new shareholders. The price reaction to the rights issue announcement should also be less negative. This thesis also examines the implications around rights issue announcements based on other theoretical models and offshore empirical evidence of equity issue effects. Other factors hypothesised to explain differential price reaction around the rights issue announcement date include underwriter certification, the level of information asymmetry, the relative size of the rights issue, use of proceeds of the issue, growth opportunities of the firm and the subscription price discount. To test the hypotheses put forward to explain price reaction to the announcement of rights issues, a sample of 167 renounceable rights issues of ordinary equity by New Zealand listed firms over the period 1976 to 1994 are examined. In the sample of 167 rights issues, 88 rights issues were announced with no simultaneous profit and loss or bonus issue announcement, eight rights issues were announced simultaneously with a bonus issue of ordinary shares, 40 rights issues were announced simultaneously with the firm's profit and loss announcement only and 3l rights issues were announced simultaneously with the firm's profit and loss and also simultaneously with a bonus issue of ordinary shares. The empirical evidence supports the following general conclusions. ● rights issues announced with no simultaneous profit and loss or bonus issue announcement experienced a significant negative abnormal return around the announcement day. The observed significant negative abnormal return is consistent with US empirical evidence on equity price reaction to the firm-commitment underwritten offer. ● there is some evidence that firms with high expected existing shareholder participation or take-up in the rights issue experience a less negative price reaction to the announcement. The empirical evidence provides some support to the predictions of the theoretical model to rights issue announcements (described in chapter four of this thesis). ● firms that announce underwritten offers and firms that announce large rights issues relative to their current market capitalisation experience a significantly more negative price reaction to the announcement. The more negative price reaction for underwritten rights offers supports the adverse selection cost arguments of Eckbo and Masulis (1992). ● firms announcing rights issues with a high subscription price discount experience a significantly more positive price reaction to the announcement. The empirical evidence does not support the model of Heinkel and Schwartz (1986) who predict a deep discount signals unfavourable inside information by managers. Importantly the results above all hold for the 'clean' sub-sample of 88 rights issues announced with no simultaneous profit and loss and/or bonus issue announcement.