Motivations that underlie the subscription prices in common stocks rights offerings: industrial firms

Abstract

The objective of this paper is to investigate the subscription price decision in a common stock rights offering. The competing prediction of the Heinkel and Schwartz model, in which a higher subscription price signals a higher quality firm, and the Myers and Majluf model in which the firm sets a low subscription price in order to secure the financing for a positive NPV project from the firm's existing stockholders are examined. For a sample of 69 industrial firms, the two-day offering period cumulative abnormal return is estimated using standard event study methodology. The relative subscription price is defined as the ratio of the subscription price to the mean of closing prices of the five trading days immediately preceding the two-day offering period. The sample was divided into two subsamples according to high and low relative subscription prices. The results indicate that industrial firms conform to the theoretical predictions of the Heinkel and Schwartz model. Higher quality firms use the subscription price in a rights offering as a signalling mechanism to distinguish themselves from lower quality firms. Relative subscription price is positively and significantly associated with the CAR. Apparently for industrials, securing the financing of a project is not a primary consideration.