Price Discounts in Rights Issues: Why Do Managers Insist on What Investors Hate?

Abstract

We analyse the causes and impact of the significant mean price discounts (25% for financial and 29% for non-financial firms) in rights issues in the UK using a sample of 264 observations for the period of 1994 to 2006. We observe that for non-financial companies the issue terms announcement returns are negatively affected by the discount size, while firm size, growth prospects and good previous stock performance have a positive impact. We also investigate which factors seem to influence managers to engage in deeper discounts when these are so disliked by investors. Evidence is provided that firms with more leverage, larger bid-ask spreads or suffering losses tend to choose deeper discounts. We conclude that managers balance the expected negative reaction of the market to a price discount with the risks of a costly issue failure, with these being higher when the firm experiences losses, has a higher volatility and also when the stock market climate is more adverse.