Does the textual quality of prospectuses affect gross spread in seasoned equity offerings?

Abstract

We examine how expositional quality (measured by discretionary readability and lexical focus—new measures) in the textual content of prospectuses preceding seasoned equity offerings affects the gross spread after controlling for the quality of numerical information. We measure the gross spread as the difference between the offer price and the underwriter's purchase price per share, expressed as a percentage of the offer price. We find that the gross spread is higher in firms whose prospectuses have lower discretionary readability, while the discretionary readability of the preceding 10‐K has little effect. Further, when the prospectus readability is lower than that of the preceding 10‐K, the gross spread increases more than it decreases when readability is higher by the same amount. Low focus (lexical focus) in the Use of Proceeds section of the prospectus results in a higher gross spread. However, low prospectus focus is associated with higher gross spread only in the bad‐news subsample. Overall, our results show that the gross spread is incrementally associated with textual obfuscation over the numerical quality of earnings. Moreover, our findings indicate that investors get distinctly different and useful information from different measures of textual quality in different parts of the text. Finally, we present novel insights showing that investors respond differently to different measures of textual quality, for example, readability and lexical focus, depending on whether there is good or bad news.