Financing investment and market timing appear to be two motivating factors for equity offers

In Motivations for Public Equity Offers: An International Perspective, Kim and Weisbach set out to examine how raising capital to finance investment and market timing act as motives for the issuance of equity. The data indicates investment does significantly increase following an equity offering, as changes in certain accounting variables are observed for every dollar of equity raised. Estimates show that firms invest about 18.8 cents in R&D and 7.3 cents in capital expenditure for every dollar raised from an equity offering during the year following the offer. The data also showed that company’s hold onto a lot of the cash raised in offerings, and this fraction is larger when companies are potentially overvalued at issuance. Furthermore, it was observed that potentially overvalued firms were more likely to issue secondary offerings, which only involves the sale of shares by insiders. These factors indicate that many companies may be attempting to time the market in order to get the highest sale value for their shares. These facts indicate market timing is another motivation behind the issuance of equity.

To examine the effect issuing equity has on the level of investment in a firm, if any, the authors look to a number of accounting variables and observe the changes that result from an equity offering. The variables are chosen based on the extent to which they capture the uses of raised capital from an SEO (seasoned equity offering) or IPO. The variables they consider include: total assets, inventory, capital expenditures, acquisitions, R&D, cash, and long-term debt reduction. They will measure the increase or decrease in each of these variables over a few time periods, which range from one to four years. The data gathered can then be used to compare results across different stock offering types.

The authors compare how the accounting variables (which signal investment) increase when primary equity is issued versus when secondary equity is issued. Primary offerings, which sell new shares, raise capital, while secondary offerings, which sell already existing shares, have no revenue consequences and no new capital is gained. Kim and Weisbach predict firms that issue primary shares will invest more capital into the company after issuance, but its difficult to know whether or not the company would have invested this money anyway, had there been no stock offering. To see if this increase in investment would have occurred had no new capital been raised, they examine the actions of firms that issue secondary shares also. Since no new capital is raised from secondary shares, if investment increases after this type of share offering as well, then it would appear raising capital to finance investments is not a main reason firms issue primary shares. However, the results show that investment does increase more when a greater number of primary shares are issued in an offering. The motivation for issuing primary shares appears to be to raise capital for financing investments, otherwise the company could have simply issued secondary shares.

The effect on investment is then examined separately for SEOs and IPOs. The SEO and IPO data is gathered from the SDC Global New Issues Database, while the accounting data for the sample is taken from WorldScope, a company that provides basic financial information on public companies worldwide. Since SDC offers poor records on IPOs and SEOs before 1990, the chose to only look at companies with equity offerings after January 1990, and up to December 2003. From these firms they choose only non-regulated private firms that issue publicly traded equity. They first observe IPOs, and the final sample contains data on 16,958 IPOs and 12,373 SEOs gathered from 38 different countries.

It is shown empirically that IPOs with pure primary share issuance increase the accounting variables the most, signaling the strongest capital investment. The next largest increase was found in IPOs comprised of a mix of primary and secondary shares. More specifically, the increases in each accounting variable per dollar of capital raised were as follows:

1. R&D expense increased 18.8 cents in a year, and by 84.8 cents over a four-year period.
2. Capital expenditures increased 7.3 cents in a year, and by 14.3 cents over a four-year period.

For SEOs, statistically significant increases in accounting variables were found in R&D, capital expenditures, acquisitions and inventory. A major difference between IPOs and SEOs was the magnitude of the effect on cash holdings. The results per each dollar raise in an SEO were as follows for cash holdings: a rise of 62.1 cents in a year, and 46.8 cents after 4 years, significantly less than the results for IPOs (106.7 in a year, 88.8 over 4 years). This difference suggests that market-timing motivations may be more apparent in IPOs than in SEOs, as significantly more capital is raised in an IPO (shares are more valuable when issued). This connection is made because more money is raised during IPOs, implying that managers are waiting to sell shares when the market places a high value on the stock.