Pricing efficiency of stock rights issues in Malaysia

Abstract

This article undertakes an empirical examination of pure rights issues in Malaysia. Though pricing efficiency is the main focus, we also examine related issues. We study a total of 38 pure rights issues that occurred over the 8-year period January 1998 to December 2005. Using two alternative valuation models, the adjusted Black–Scholes Call Option Model (BSOPM) and the traditional Implied Rights Valuation Model (IRVM), we find the Malaysian market to be inefficient in pricing the rights. Mispricing is quite extensive with a predominance of overpricing. Significantly, both pricing models, despite their different theoretical underpinnings produce similar results. These results are further validated by the returns to our two arbitrage strategies. The trading strategy, which establishes a net short position in the rights produces substantial positive returns, whereas the strategy which effectively goes long the rights, produced marginally negative returns. We found underlying stock price volatility, liquidity and moneyness of the rights to be the key determinants of the extent of mispricing. Finally, we find that underlying stock price volatility was significantly lower post rights issue.

Notes

¹ A situation similar to that of the UK. Burton and Power (2003), find that the typical amount of funds raised through rights issues in UK is considerably larger than in other methods such as shares placement.

² The outstanding percentage of a warrant is the percentage held by investors, relative to that held by the issuer.

³ To be included in our sample, the rights must have been traded over at least 50% of its listed number of days.

⁴ Daily mispricing by IRVM is also computed using Equation 4.

⁵ Percentage trading is the liquidity of the rights within the rights trading period. If rights are traded everyday of trading period, its percentage will be 100%. Otherwise, percentage = (Number of days traded/Total trading period in days).

⁶ Moneyness is determined as: (Stock price – (Example Price of right × Number of Rights per Share)).

⁷ The assumption in both strategies is that we buy/sell enough rights according to the rights allocation ratio to buy/sell one stock.

⁸ Though both strategies are settled on day 30 after listing of the rights induced shares, there is a difference of a few days between when they are initiated. The size of the difference though small, varies across companies (Section I, institution setting). We ignore this timing difference in comparing percentage returns.

⁹ Volatility is determined using daily closing price over the window period for each sample stock.

¹⁰ This is a longer window, needed to neutralize volatility changes due to information leakage just prior to announcement date (see, Ariff et al., 1998 for information about leakage preannouncement).

¹¹ Malaysia's stock exchange has two boards, the Main and Second board. The latter is for smaller and more recently established companies.

¹² According to Burton et al. (2004), deeply discounted rights issues have attracted renewed attention in recent years as market regulators search for ways of driving down the cost of external fund raising.

¹³ Our test for multicollinearity showed no evidence of the problem. Results of these diagnostics and VIF are not shown due to space constraints.

¹⁴ Results by individual issue are not shown due to space constraints.

¹⁵ Detailed results are not shown due to space constraints (available from author).