SEO Timing, the Cost of Equity Capital, and Liquidity Risk

Abstract: We use a parsimonious asset pricing model to capture time-varying risks surrounding seasoned equity offerings (SEOs) to shed further light on the debate of what causes the ability of firms to time SEOs to periods that are followed by low stock returns. Our results show that (1) managers do not know when the lowest cost of equity capital would occur until it passes, but they promptly file for SEOs right after it does; (2) the pre-filing decline in the cost of equity capital is largely due to market-wide improvements in risks and an additional decrease in SEO firms ‘ liquidity risk; (3) their cost of equity capital rebounds but remains relatively low at issuance and thereafter for two to three years, largely due to liquidity risk staying low, relative to comparable non-issuers; (4) controlling for market risk and liquidity risk is sufficient to show no abnormal returns in the post-issue period; and (5) the SEO announcement return is less negative and investors demand a lower offer price discount on issuing firms that experience more post-issue liquidity risk reduction. Our findings are inconsistent with the behavioral explanation that managers time SEOs to exploit market inefficiency, and the investment-based explanation that SEOs allow issuing firms to convert growth options into assets in place, thus reducing their post-issue systematic risks. Rather, our findings suggest that, to minimize the cost of equity capital