Economic influence on rights issue announcement behavior in Malaysia

Ž .Pacific-Basin Finance Journal 7 1999 405–427www.elsevier.comrlocatereconbase

Economic influence on rights issueannouncement behavior in Malaysia

Norhana Salamudin a,1, Mohamed Ariff b,),Annuar Md Nassir c,2

a Faculty of Business and Management, Institut Teknologi MARA, 40450 Shah Alam, Selangor,Malaysia

b Monash UniÕersity, Business School, 27 Sir John Monash DriÕe, P.O. Box 2224, Caulfield Junction,Victoria 3161, Australia

c Faculty of Economics and Management, UniÕersiti Putra Malaysia, 43400 Serdang, Selangor,Malaysia

Abstract

The negative announcement period return for seasoned equity issues in several devel-oped share markets has been explained as an adverse selection effect to informationasymmetry between managers and investors during the expansionary phases of share marketcycles. This paper reports a significant positiÕe announcement period return in an emergingshare market. The average return during periods of favourable economic conditions is

Ž .higher than return during unfavourable periods. The term premiums, which decline riseŽ .during favourable unfavourable economic conditions, are correlated with announcement

period returns. These findings support the good news hypothesis that the return is positivebecause investors expect the funds from issues to be used in profitable investment projectsin a high growth emerging economy. q 1999 Elsevier Science B.V. All rights reserved.

JEL classification: G17

Keywords: Rights issues; Term premiums; Seasoned issues; Demand for capital

) Corresponding author. Tel.: q61-3-9215-1809; fax: q61-3-9215-1815; e-mail:[email protected]

1 Tel.: q60-3-5564145; fax: q60-3-5508104; e-mail: [email protected] Tel.: q60-3-9486101 ext. 1627; fax: q60-3-9486188; e-mail: [email protected]

0927-538Xr99r$ - see front matter q 1999 Elsevier Science B.V. All rights reserved.Ž .PII: S0927-538X 99 00010-4

( )N. Salamudin et al.rPacific-Basin Finance Journal 7 1999 405–427406

1. Introduction

Economic factors have been shown to cause temporal variations in the volumeŽ .of seasoned equity issues coming on to the share markets. Choe et al. 1993

demonstrated that seasoned equity issues tend to cluster during certain timeperiods coinciding with the bullish phases of share marketrbusiness cycles. Anegative price effect to seasoned equity announcements has been recorded inseveral developed share markets. That effect, however, has been found to be lessnegative during periods of favourable economic conditions. The effect of eco-nomic conditions on price behavior of seasoned equity issues has been researched

Žin the US share markets but not in other developed markets see Choe et al., 1993;.Bayless and Chaplinsky, 1996 .

Little research has been done on this topic in the emerging markets, anŽ .exception being Ariff and Khan, 1997 , which showed that announcement period

returns are also negative during periods of economic recession. However, apositive rights issue announcement period return has been reported in several

Ž . Žpublications, which include Kim and Lee, 1990 for Korea and Ariff and Finn,.1989; Srinivasan and See, 1990 for Singapore. This research concerns the price

behavior of the rights issues in an emerging share market, Malaysia. The researchproceeds by measuring the average abnormal returns around the event dates ofrights issues and then investigating possible reasons to explain why a positiveannouncement effect is found in this emerging share market. This leads to theidentification of factors from three different levels namely macroeconomic, marketand firm levels.

This study finds that rights issues exhibit positive announcement period return,a result similar to those found in Korea and Singapore and is anomalous to thenegative returns reported in most developed share markets. As noted before, thenegative price effect has been explained in terms of adverse selection where pricesdecline as a result of information asymmetry. Corporate management’s decision toraise investment funds by issuing rights are motivated by the knowledge thatshares are overvalued during the bullish period share market conditions at the timeof the issues. Investors respond by reducing prices since management is signallingabout overpriced stocks. The profitable investments from proceeds of the issuesare ignored. There is also a potential for dilution of control when unsold rights arebought by outsiders.

Investigating the reasons for a positive price effect in a high growth emergingeconomy, we find that the term premium of interest rates plays a significant role indetermining the demand for share capital. This suggests that it is the economicconditions that are associated with this seemingly anomalous positive price effectin this share market, providing indirect evidence about investor expectation aboutpositive net present value investment opportunities for funds raised during periodsof economic prosperity. Investors therefore react favourably in emerging marketsto the announcements of rights issues because corporate management’s decision to

( )N. Salamudin et al.rPacific-Basin Finance Journal 7 1999 405–427 407

issue rights signals expectations of profitable investment opportunities while termpremiums are also declining during the high growth phase in such an economy,especially during periods of favourable economic conditions.

The remainder of the paper is organised as follows. Section 2 describes thetheory and evidence on the economic and market influences on price behavior ofrights issues. A number of studies, which identified possible factors associatedwith the announcement effect, are briefly reviewed in Section 3. Section 4describes the data sources, methodology and research design while the findings arepresented in Section 5. The conclusions of this study are found in Section 6. Whilenot ruling out possible alternative explanation, especially for the persistent butinsignificant price declines in the periods after announcements, this paper suggeststhat economic conditions are primarily responsible for the positive price effects

Ž .recorded in this and possibly other emerging share market in the periods priorto the announcements of rights issues. Changes in term premiums appear to proxyas a factor for this positive effect.

2. Economic and market influence on seasoned equity issues

2.1. Economic influence

It has been observed that managers take advantage of favourable economicŽ .conditions when issuing equity Korajczyk et al., 1990 . Certain periods are

favoured because share prices are high in those periods thus reducing the numberof new shares to be issued while also lowering the issue costs in fund raising.Consequently, this limits the dilution of ownership of current shareholders sincethere will be less unsold rights that could be bought by outsiders. Choe et al.Ž .1993 observed a clustering of equity issues during periods of economic expan-

Ž .sions as classified by the US National Bureau of Economic Research NBER .They also found that the announcement period price drop resulting in the negativeannouncement period return is much smaller for issues made during such periods.

ŽThey explain such price behavior to be the outcome of adverse selection Myers.and Majluf, 1984 and suggest that the outcome varies over the businessrmarket

cycle. During periods of economic expansion, more investment opportunities areavailable and investors are less concerned with overvaluation, thus the pricedecline slows down relative to price declines in the periods of recessions. Thispattern of time varying price behavior supports the belief of the investmentcommunity that capital can be raised at favourable terms during businessrmarketcycle expansions.

Ž .Berkowitch and Narayanan 1993 presented a dynamic model in which thefinancing and investment decisions of firms are shown to be interrelated as beinglinked to economic and capital market conditions. They showed that more projects


are financed with equity when economic conditions improve while more debtfinancing takes place in a declining economy. They used two assumptions in their

Ž .model: i firms can choose to delay development of their projects in periods ofŽ .adverse economic conditions, and ii financial markets are not perfectly competi-

tive. Economic conditions influence the type of projects, whether high or lowquality, undertaken by firms. When the economy is in a recession, only highquality projects will be developed while low quality ones are postponed. During aneconomic expansion, firms will be able to take on more projects that includecurrent high quality ones and postponed low quality projects from previousperiods. This results in more equity financing during an economic uptrend andmore debt financing vice versa.

Ž .Bayless and Chaplinsky 1996 associated the clustering of rights issues toinformation costs, which are low as a result of low information asymmetrybetween managers and investors. They showed that a favourable window ofopportunity exists for issuing seasoned equity. Hot and cold periods are classifiedaccording to the volume of capital issues, on an ex-post basis. Greater volume ofequity being issued at certain time periods is consistent with time-varying asym-metric information. Significant differences in average values of macroeconomicand market factors—such as the leading indicators, term premium and defaultpremium—are found to vary between the periods: cold markets having the lowest,followed by normal and hot markets. These documented differences indicate theneed to factor in macroeconomic and market influences in any study of theannouncement day abnormal return.

Research on the influence of interest rates on stock returns divides interestpremium into two parts. The first part is the term spread, which is the difference

Žbetween yield on Aaa bonds and the 1-month Treasury bill rate Fama and French,.1989 . The term spread is highly correlated with the pattern of the short-term

Ž .business cycle. According to Chen 1991 , the term spread is positively related tofuture real activity. At business peaks, poor prospects for future real investmentactivities and portfolio investments explain the low expected returns. Sincebusiness cycle peaks coincide with low term spread, the relationship between termspread and expected returns is thus positive. The other part of interest premium isthe default spread represented by the difference between the average return oncorporate bonds and the Aaa bond yield. This value reflects long-term businessconditions, which is high during recessions and low during economic boom.

2.2. Stock market influence

Performance of the stock market also influences financing decisions made byŽ . Ž .firms. According to Taggart 1977 and Marsh 1982 , the probability of rights

Ž .issues increases after a market rise. Masulis and Korwar 1986 and Korajczyk etŽ .al. 1990 supported this prediction by showing that stock issues are made

following market rises. Masulis and Korwar found a significant positive relation


between the 60-day pre-announcement cumulative return of the market and theannouncement day price decline with the result that the larger the cumulativemarket return, the smaller is the observed price decline.

Ž .Bayless and Chaplinsky 1996 do not find evidence to support the abovefindings. They found that the 1-year pre-announcement cumulative market run-upis negatively related to the price drop on announcement day. Korajczyk et al.Ž .1990 showed that the length of time in which market return is cumulated isresponsible for such discrepancy in results.

3. Price behavior of seasoned equity issues

Considerable attention on seasoned equity offerings, the subject of this paper,has been drawn lately to the peculiar price patterns exhibited around announce-ment time. In general, announcement of equity issues showed a significant pricedecline after a trend of increasing prices in the pre-announcement period. This istrue for general cash offers in the developed US and UK markets. However,opposite results were obtained for seasoned equity offers in the form of rightsissues in the developing markets of Singapore, Malaysia and Korea.

Singapore rights issues showed price increases before rights announcements,Žwhich decreases in the post-announcement period Ariff and Finn, 1989; Srini-

.vasan and See, 1990 . Studies in Malaysian share market evidenced mixed resultsŽ .in the pre-announcement periods. Phoon 1990 demonstrated the usual price

Ž .increases while Annuar and Shamsher 1993 found a negative abnormal return inthe one month prior to announcement. Investigation into the price behavior of

Ž .Korean rights offers by Kim and Lee 1990 revealed different results compared tothe US. Price run-up of Korean issues occurred for 2 months in the pre-announce-ment period and continued for another 2 months in the post-announcement period.This behavior can be explained in terms of news leakage as well as investorexpectation of profitable investment opportunities in the pre- and post-announce-ment periods, respectively. The favourable response is attributed to the fact thatKorean firms face high costs of equity financing and will only choose suchfinancing method if the returns from expected investment opportunities outweighthe already high costs. In a cross-sectional analysis of the post-announcementreturns against size of issues, the researchers found a significant positive relation-ship indicating investors’ reaction being influenced by size of projects beingfinanced. Their findings strongly support the good news hypothesis that costlyequity financing is being used to finance positive net present value investmentopportunities, which induce positive price response from investors.

Ž .Myers and Majluf 1984 proposed an adverse selection model where managershave superior information regarding the value of assets in place and will use suchknowledge for the benefit of existing shareholders who are assumed to be passive.Even though, on average, firms are correctly valued by the market, there exist


pockets of inefficiencies where individual firms are temporarily mispriced. Whenthe prevailing market price is much higher than the intrinsic value, managers findan incentive to raise cheaper funds through new equity issues. Rational investorsregard this action as conveyance of negative information that the firm is currentlyovervalued. Consequently, investors lower their assessment of market valuecausing share prices to drop resulting in the now well documented negativeannouncement period return in the developed markets. This hypothesis indicatesthat the greater the information asymmetry the greater would be the price decline.

One of the reasons firms issue equity is to acquire additional funds to financepositive net present value projects. The presence of favourable investment oppor-tunities is good news to investors and should induce positive price response upon

Ž .disclosure of such event. McConnell and Muscarella 1985 documented favourableinvestor reaction to announcements of capital expenditure plans. In the case ofrights issues, assuming asymmetric information, market reaction to the issuedecision depends on firm’s ability to signal private information about the availabil-

Ž .ity of profitable investment projects. Ambarish et al. 1987 developed a signallingequilibrium with dividends and net new issue of stocks. They showed that reactionto announcements of new issue of stocks is negative when firms have privateinformation about the value of assets in place, positive when the information

Ž .concerns investment opportunities. Cooney and Kalay 1993 modified the modelŽ .of Myers and Majluf 1984 and showed that a positive reaction is indeed possible

if the market anticipates a valuable investment opportunity associated with theequity issue. Thus, it is predicted that high growth firms with abundant investmentopportunities, for example in a high growth emerging economy, will thus experi-ence positive announcement returns while low growth ones lead to negativereturns.

Attempts at testing the model of Ambarish et al. have produced mixed results.Ž .Barclay and Litzenberger 1988 , using Tobin’s q to proxy for growth opportuni-

ties, found a positive but insignificant relationship with announcement day return.Ž . Ž . Ž .Meanwhile, Dierkens 1991 , Pilotte 1992 and Jung et al. 1996 found evidence

consistent with the prediction of Ambarish et al. that the presence of profitablenew investment opportunities reduces the decline in announcement period returnin stock offerings.

Dierkens measured growth opportunities in terms of the ratio of market to bookvalue of equity and found a significant positive relationship with rights issueannouncement return. Pilotte divided his sample into high growth and low growthfirms based on their dividend policy, where firms with no dividends paid, areclassified as growth firms and those with high andror stable dividends areclassified as matured firms. Mature firms experience greater announcement pricedeclines than high growth firms. Further support for the hypothesis is alsoprovided by Jung et al. who found a significant positive relation betweenannouncement period return and market to book value of assets as a proxy for theavailability of good investment opportunities.


That investing in positive net present value projects will enhance growth ofŽ .firms is also supported by the findings in Denis 1992 in a developed market. He

showed that high growth firms experience insignificant negative disclosure effectwhile low growth firms experience significant negative returns. His high growthsample had lower book value to total assets, implying high market to book valueratio.

4. Data sources, methodology and research design

The rules on pre-emptive rights in Malaysia make it mandatory for companiesto offer additional equity to existing shareholders before offering to other parties. 3

The purpose of this ruling is to protect the interests of existing shareholders toprevent dilution of ownership control in the company. Decision to raise additionalcapital through a rights issue must first be approved by existing shareholders in ageneral meeting before a firm seeks the approval of the Securities CommissionŽ .SC and the stock exchange, the KLSE. All rights issues must be underwritten bya merchant banker and must be renounceable in favour of a third party at theoption of existing shareholders. 4 The company needs to prepare a prospectus tobe circulated to all shareholders. 5 As underwriter, the merchant banker is respon-sible for taking up any issues not fully subscribed by existing shareholders and byoutside investors, if renounced. The underwriter is also responsible for managingthe issue in terms of document preparation, organisation and liaison with relevantauthorities. Besides underwriting, the merchant banker advises on the appropriatenumber of shares to be issued, suggests the offer price based on net tangible assetsof companies, projected earnings and dividends while also determining the timingof the issue based on a study of the prevailing market conditions.

According to the CIC Guidelines for the New Issue of Securities and theŽ . 6Valuation of Public Limited Companies CIC, 1992 , proceeds of rights issue

can only be utilized for investment in viable projects, for expansion of productivecapacity and, if approved in the prospectus, for loan repayment. The SC will notapprove rights issues for the purpose of refinancing cash acquisitions of assets andto reduce short-term borrowings of a recurrent nature. Therefore, the regulatoryoversights in this share market is biased against rights issues from being used forother than profitable capital investments most of the time, and in some cases forrepaying long term debt.

3 Fourth Schedule, Table A of Companies Act 1965 and Part 8, Section 287 of the KLSE MainBoard Listing Manual.

4 KLSE Main Board Listing Manual: Part 2, Section 48.5 Part 4, Section 37, Companies Act, 1965.6 CIC is the Capital Issues Committee, whose functions have been assumed by the Securities

Commission since March 1993.


4.1. Data

The sample comprises all rights issues made during the period over January1980 to December 1995. The 16-year period is considered appropriate as itincludes periods of market declines of 1987 and the bull runs of 1992r1993,representing market and business cycles in this high growth economy. 7 The

Žannouncement dates were identified from the InÕestor’s Digest formerly KLSE.Gazette . This market is well covered by news releases in the mass media and

there is an active investment community participating in the market. Only purerights issues uncontaminated by other events during the test window over y60and q20 days around announcement were finally selected to ensure that theresults are not biased by other confounding information effects. Share price andKLSE Composite Index data were collected from the Securities Clearing Auto-

Ž .mated Network SCAN daily price tape and the KLSE Daily Diary. Prices wereŽ .adjusted for any capitalisation changes bonus and rights but not for dividends: all

rights announcements with dividend announcement in the test window were alsoexcluded.

The book values of debt, equity, and total assets for the previous fiscal yearprior to rights announcements for the company were obtained from the variousKLSE Annual Companies Handbook. Information relating to the purpose of issueas well as the amount of funds apportioned to the various purposes were alsocollected from individual company prospectus found in the folders kept at theKLSE Library.

Between 1980 to 1995 a total of 255 rights offerings were made. Ninety-fivewere mixed with bonus issues while 39 were concurrently announced withacquisition plans and another 38 with special issues and restructuring schemes.This left 83 issues of which seven were made on the same date as dividendannouncements and four were voluntarily suspended before rights offer announce-ments. The sample was thus reduced to 72 companies of which only 60 hadprospectuses filed at the KLSE Library.

4.2. Methodology

The event study methodology 8 is used to examine price behavior of rightsissues. The excess return on a particular share at various intervals during the event

7 This economy grew at an average real rate of 9.14% per annum during the study period. Economicrecession was experienced during the years 1979, 1981 and 1986–1987.

8 Ž . Ž .The event study as developed by Ball and Brown 1968 and Fama et al. 1969 has beenŽ .subsequently refined by Brown and Warner 1985 . As the method is well entrenched in several

studies, no further details are given in this paper.


period of interest is calculated first, then averaged cross-sectionally and finallycumulated over time to detect any abnormal price pattern. 9 Abnormal return of a

Žcompany, A , is the difference between actual share return and normal ori.expected return as in

A sR yE R , 1Ž . Ž .i t i t i t

where A is the excess return or residual of security i for day t, t the dayi t

measured relative to the event of interest, R the actual return on security i at dayi tŽ .t, and E R the expected return on security i for day t.i t

In this research, the market adjusted return method is used where it is assumedthat the expected return on security i at day t is equivalent to the return on themarket portfolio. The value-weighted KLSE Composite Index is used to approxi-mate the market portfolio to estimate the expected return. Use of the marketadjusted model has been shown to yield valid findings by several studies. For

Ž .example, a simulation by Dyckman et al. 1984 showed that the three commonlyŽ .used models mean-adjusted, market-adjusted and market models have similar

ability to detect the presence of abnormal performance. Another simulation studyŽ .by Brown and Warner 1985 found that the market-adjusted model produces

approximately the same number of Type I errors as the more complex marketmodel, which adjusts for risk. They concluded that the power to detect abnormal

Ž .return is not improved by risk adjustment. Chandra et al. 1990 , Korajczyk et al.Ž . Ž .1990 and Krueger and Johnson 1991 demonstrated no lack of power of themarket-adjusted model in anomaly studies. Korajczyk et al. calculated the cross-sectional correlation using various methods including the market-adjusted method,

Ž .capital asset-pricing model with Scholes and William 1977 method of systematicrisk estimation and beta-sorted comparison portfolio method. Thy found highcorrelation of between 0.85 to 0.99 between results using different methods. Lease

Ž .et al. 1991 used the market adjusted and the market model to study marketmicrostructure impacts on seasoned issues and found that all ‘procedures yieldqualitatively similar results.’ 10

Ž .The average abnormal return AAR return for each time period t ist

N1AAR s A , 2Ž .Ýt i tN is1

where N refers to the number of securities in the sample and A the abnormali t

return of the ith rights issue at time t. The cumulative average residuals denoted

9 Daily arithmetic returns were calculated.10 Ž .See Lease et al., 1991, footnote 10, p. 1527 .


by CAR are calculated by summing average excess returns over days K to LŽK , L.in the test window as follows

L

CAR s AAR . 3Ž .ÝŽK , L. ttsK

Test of significance is done by calculating the t-statistics, which is the ratio ofday t average abnormal return to its estimated standard deviation. The standarddeviation is estimated from the time-series mean excess returns over days y300 toy61 representing 240 days estimation period. This is outside the event period ofy60 to q20 so that the result will not be biased. The t-value is given by 11

tsAAR rS AAR , 4Ž . Ž .t t

Ž .where S AAR is the standard deviation of average residual returns equivalent tot

tsy612US AAR s AAR yA r239 , 5Ž . Ž . Ž .Ýt t)ž /

tsy300

tsy611UA s AAR , 6Ž .Ý t240 tsy300

AU is the abnormal return over y300 to y61 days relative to announcement.t-statistics for CAR is 12

ŽK , L.

tsCAR rS CAR , 7Ž .Ž .ŽK ,L . ŽK , L.

Ž .where S CAR refer to standard deviation of cumulative average residualsŽK , L.over days K to L, calculated by

S CAR s T var AAR , 8( Ž . Ž .Ž .Ž .ŽK , L. t

Ž .where T equals the number of days in the CAR statistics and var AAR ist

variance of abnormal returns during the estimation period.The market adjusted abnormal returns are calculated over days y60 to q20

relative to announcement days0. The average residuals are cumulated anddivided into three sub-periods: pre-announcement, announcement, and post-an-nouncement. The announcement day is the actual day of announcement asrecorded in the InÕestors’ Digest. This refers to the day when KLSE receivesrights issue announcement notice from the companies, which will then appear inthe local newspapers the next day. The announcement date when the informationis made public is thus q1 instead of zero as frequently referred to by researchersin the US and the UK. The result of daily average abnormal return is then used to

11 Ž .Brown and Warner 1985 , p. 7.12 Ž .Asquith and Mullins 1986 , p. 69.


decide on the best cut-off points to classify cumulative returns into pre-, post-, andannouncement sub-periods.

4.3. Research design

Cross-sectional tests using the three theoretical elements that explain pricebehavior of rights are employed. First, the regression is run with abnormal returnas the dependent variable and selected variables based on theory as independentvariables. Various proxies for the three elements incorporating information asym-metry, price pressure and growth opportunities are used. Variables used to proxy

Ž .information asymmetry are logarithm of total assets LTA , relative offer priceŽ . Ž .ROP , and standard deviation of abnormal returns for days y60 to y9 SDAR .

Ž .Price pressure is proxied by logarithm of gross amount raised LVOL and relativeŽ .size of issue RSIZE . Proxies for growth opportunities are market to book value

Ž . Ž . 13 Ž .of equity MVBV , Tobin’s q ratio TOBINQ , and return on assets ROA .The independent variables finally employed in the regression are those with lowcorrelation coefficients to avoid problems of multicollinearity.

The tests were repeated by sequentially adding market timing variable proxiedby the cumulative return on KLSE Composite Index for days y60 to y9.Economic condition was then incorporated as a dummy variable. For periods ofdeclining term premiums, indicating favourable economic condition, a value of 1is used while 0 represents periods of rising premium considered to be un-favourable. Further analysis was conducted by incorporating tests of heteroscedas-ticity and necessary steps taken to correct for violation of the OLS assumptions.

5. Results

The market adjusted abnormal returns and cumulative abnormal returns for thesample of rights issues made over 1980 to 1995 are given in Table 1. In thepre-announcement period over y60 and y1 days, the sample exhibited significantpositive cumulative abnormal returns of 15.88%, significant at 0.01 level. The

Ž . Ž .returns over 0 to q1 and q2 to q20 days are y0.91% and y1.98%, respec-tively, both being not significant different from zero. On event period effect is notsignificant but pre-event effects are statistically significant. These cut-off pointsfor categorizing cumulative returns into pre-announcement, announcement andpost-announcement periods are based on the norms used by other researchers indeveloped markets. For the emerging markets, which are smaller and withprevalent insider trading, a different set of cut-off points is considered moreappropriate.

13 Ž .The formula modified by Chung and Pruitt 1994 is used to calculate Tobin’s q.


Table 1Ž . Ž .AAR and CAR from 60 days before to 20 days after announcements of rights issues

a bDay AAR t-value CAR

y60 y0.0021 y0.60 y0.0021y50 y0.0027 y0.75 0.0232y40 y0.0046 y1.27 0.0379y30 0.0050 1.39 0.0696

UUy20 0.0075 2.10 0.1027y10 0.0018 0.49 0.1202y9 y0.0004 y0.12 0.1198y8 0.0021 0.58 0.1219

UUUy7 0.0117 3.26 0.1336y6 y0.0002 y0.05 0.1334

UUy5 0.0078 2.16 0.1412y4 y0.0038 y1.06 0.1374

UUy3 0.0094 2.60 0.1468Uy2 0.0062 1.72 0.1529

y1 0.0058 1.62 0.15880 y0.0013 y0.35 0.1575

UUq1 y0.0078 y2.17 0.1497q2 y0.0049 y1.36 0.1448q3 y0.0019 y0.52 0.1429q4 y0.0059 y1.65 0.1370q5 y0.0059 y1.63 0.1311q6 y0.0043 y1.19 0.1268q7 y0.0025 y0.71 0.1243q8 y0.0023 y0.63 0.1220q9 y0.0024 y0.67 0.1196q10 y0.0018 y0.50 0.1178q20 y0.0017 y0.48 0.1299

UUUŽ .y60 to q20 3.81 0.1299UUUŽ .y60 to y1 5.39 0.1588UUUŽ .y60 to y9 4.35 0.1198UUŽ .y8 to q1 2.58 0.0299

Ž .0 to q1 y1.73 y0.0091Ž .q2 to q20 y1.23 y0.0198

aAverage abnormal returns.bCumulative average abnormal returns: the CAR is cumulated over each day although the numbers inthe 50s, 40s, 30s, 20s and teen ranges are not shown in the table.Significance level: UUU 1%, UU 5%.

Accordingly, we provide more tests over different periods. The pre-announce-ment cumulative return from days y60 to y9 is 11.98%, significant at 0.01 level.The cumulative announcement period return measured over y8 to q1 days—re-call slow dissemination of news in this market—is 2.99%, significant at 0.05.Price behavior in the pre-announcement period is consistent with those of thedeveloped markets where upward movement of share prices occur before an-


nouncement of the event. However, significant price increases over about 8 daysbefore the actual announcement indicate possibility of news leakage by insiders.

Similar results have been documented in Singapore and Korea. News ofimpending rights issues are regarded favourably by investors causing pre-announ-cement returns to be significantly positive. Such response could have beentriggered by favourable future outlook for the company due to the availability ofprofitable investment opportunities in a generally high growth economic situationin the tested market. The post-announcement period price reaction shows nosignificant price movements, supporting the semi-strong efficient market hypothe-sis. But there is persistent but small declines in prices in the announcement andpost-announcement periods. This could be due to thin trading in the post-announ-cement period after active interest in these shares has waned in thin market.However, the declines are not significant. 14

5.1. Returns under Õarying economic conditions

The influence of economic conditions on timing of rights issues is obviousupon segregating the sample into two groups based on rising and falling termpremiums. Managers prefer to raise additional financing through rights offeringsduring periods of falling term premium as this will reduce cost of equity. Out of72 rights issues in the sample, 56 were made during the periods of falling term

Ž .premiums favourable economic conditions and 16 during unfavourable condi-tions. This cannot be due to a random occurrence because testing for thehypothesis of equal distribution produces a chi-square value of 23.68 with 0.01level of significance. This shows that rights issues are more likely to be madeduring periods of falling term premiums.

Table 2 summarizes the abnormal returns and cumulative abnormal returns ofthe two samples. Issues made during periods of favourable economic conditionshave larger abnormal returns and consequently higher t-values, which are statisti-cally significant compared to those made during unfavourable economicrmarketconditions. Total return over the entire estimation period is larger for the favourablerather than the unfavourable group: the former is 14.88% and the latter isy0.46%. Their pre-announcement average returns are also significantly differentwhere issues announced under favourable economic conditions experienced con-tinuous increases in prices, cumulating to 12.08% over days y60 to y9 and to16.80% over days y60 to y1. Those announced under unfavourable conditionsshow fluctuating returns that cumulated to 7.03 and 5.70% over the respectiveperiods.

14 Our examination of the volume traded in a sample of firms shows that there is generally apersistent interest in these shares.


Table 2Ž . Ž .AAR and CAR under different economic conditions over y60 before and q20 days afterannouncements of rights issues

Ž . Ž .Days Favourable f Unfavourable uf

AAR t-value CAR AAR t-value CAR

y60 y0.0024 y0.46 y0.0024 y0.0036 y0.34 y0.0036y50 y0.0028 y0.00 0.0252 y0.0034 y0.32 0.0158y40 y0.0039 y0.76 0.0463 y0.0069 y0.66 y0.0022y30 0.0042 0.82 0.0747 0.0102 0.97 0.0330y20 0.0048 0.95 0.1066 0.0143 1.37 0.0679y10 y0.0002 y0.03 0.1288 0.0075 0.71 0.0647y9 y0.0007 y0.14 0.1281 0.0086 0.82 0.0733y8 0.0011 0.22 0.1292 0.0000 0.00 0.0733

UUUy7 0.0153 2.99 0.1445 y0.0004 y0.04 0.0729y6 y0.0005 y0.10 0.1440 0.0003 0.03 0.0732y5 0.0030 0.58 0.1470 0.0047 0.44 0.0779y4 y0.0077 y1.52 0.1393 y0.0103 y0.99 0.0676

UUy3 0.0119 2.34 0.1512 y0.0060 y0.58 0.0616Uy2 0.0093 1.82 0.1605 y0.0024 y0.23 0.0592

y1 0.0075 1.46 0.1680 y0.0022 y0.21 0.05700 0.0003 0.06 0.1683 y0.0083 y0.79 0.0487

q1 y0.0057 y1.12 0.1626 y0.0058 y0.55 0.0429q2 y0.0034 y0.67 0.1592 y0.0099 y0.95 0.0330q3 y0.0028 y0.55 0.1564 0.0009 0.08 0.0339q4 y0.0084 y1.65 0.1480 0.0025 0.24 0.0364q5 y0.0044 y0.86 0.1436 y0.0122 y1.16 0.0242q6 y0.0058 y1.14 0.1378 0.0010 0.09 0.0252q7 y0.0030 y0.59 0.1348 0.0001 0.01 0.0253q8 0.0003 0.07 0.1351 y0.0074 y0.71 0.0179q9 y0.0034 y0.66 0.1317 y0.0031 y0.30 0.0148q10 y0.0005 y0.09 0.1312 y0.0064 y0.61 0.0084q20 y0.0051 y0.34 0.1488 0.0075 y0.44 y0.0046

Ž . Ž .Favourable f Unfavourable uf Differencebetween meansCAR t-value CAR t-value

UUU UUUy60 to q20 0.1488 3.07 y0.0046 y0.08 5.94UUU UUUy60 to y1 0.1680 4.08 0.0570 0.66 4.87UUU UUUy60 to y9 0.1208 3.26 0.0703 0.93 2.53UU UUUy8 to q1 0.0345 2.10 y0.0304 0.92 7.28

UU0 to q1 y0.0054 y0.76 y0.0141 y0.94 2.26

aAverage abnormal returns.bCumulative average abnormal returns. the CAR is cumulated over each day although the numbers inthe 50s, 40s, 30s, 20s and teen ranges are not shown in the table.Significance levels: UUU 1%, UU 5%, U 10%.

In the results for the on event and pre-event periods, the corresponding returnsare 3.45 and y3.04%. These are significantly different from each other at 0.05


acceptance level. But the average on event return of y0.54% over 0 and q1 daysis anomalous in sign during the favourable economic period though not signifi-cantly different from zero. But the respective number of y1.41% for the un-favourable economic period is statistically higher and negative, as noted indeveloped markets. Thus, tests over most of the tested windows show significantlydifferent results from each other. However, in the post-announcement period, bothsample means experience negative cumulative returns, being more negative for theunfavourable sample: 1.41% against 0.54%. Although the two means are individu-ally not significant, their difference is significant at 0.01 acceptance level. Pricemovements during the two economic periods are also shown in Fig. 1.

These findings indicate that rights issues made during favourable economicconditions have significantly higher announcement period return in the pre-an-nouncement period. Issues made during unfavourable conditions do not experiencethe usual pattern of increasing prices found in the favourable period issues. Thesame conclusion can be made regarding the pre-announcement period pricemovements, which during the favourable conditions have a positive cumulativereturns. In contrast, the other sample experiences negative returns indicating lessdemand perhaps symptomatic of investor disbelief that there is profitable invest-ment opportunity for funds raised during unfavourable economic conditions. Thepost-announcement cumulative return for both samples are negative but these arenot significant. The results over post-announcement periods support the usualsemi-strong market efficiency where public information is quickly impounded intoshare prices on and prior to announcements. The systematic negative AARs in thepost-announcement days may well be due to lack of investor transactions in a thinmarket: but these numbers are not significant.

Fig. 1. Rights issues under different economic conditions: f s favourable and uf sunfavourable.


Firm and issue characteristics under different economic conditions are analysednext. The results are shown in Table 3. In general, no differences exist betweenissues made during favourable and unfavourable economic conditions. On average,firms that issue rights during favourable economic conditions are slightly smallerin terms of amount of shares outstanding, leverage and return on assets. The

Ž .average outstanding shares before issue of these firms were RM 88.9 million andRM 118 million for the favourable and unfavourable groups, respectively. Returnon assets were 2.27% and 3.68% and leverage 57.2% and 59.3% for the favourableand unfavourable groups, respectively. However, differences between these aver-

Ž .ages are not significant. Total assets are slightly larger but insignificant for thefavourable group with means of RM 512.7 million and RM 472.9 million,respectively. The pre-announcement standard deviation of returns do not differfrom one another at 2.76% and 2.59% for the favourable and unfavourablesamples, respectively. Additional variables considered are Tobin’s q ratio andmarket to book value of equity. Tobin’s q was 1.85 for the favourable sampleagainst 2.26 vice versa. The market to book value of equity were 3.25 and y0.14,respectively, and were marginally significant at 0.10.

Differences in issue characteristics were also considered. For example, thegross amount of funds raised is, on average, smaller at RM 81.5 million during

Table 3Firm and issue characteristics of rights under different economic conditions

aŽ . Ž .Favourable f Unfavourable uf t-test

Firm characteristicsExisting shares RM 88.9 million RM 118 million y0.98Total assets RM 512.7 million RM 472.9 million 0.10Leverage 57.2% 59.3% y0.31

UMarket-to-book value 3.25 y0.14 1.85Tobin’s q 1.85 2.26 y1.02Return on assets 2.27% 3.68% y0.50Standard deviation of 2.76% 2.59% 0.54abnormal returns

Issue characteristicsGross amount raised RM 81.5 million RM 106.1 million y0.98Relative issue size 103% 69% 1.33Investment and working RM 51.8 million RM 67.2 million y0.74capitalRepay bank borrowing RM 33.8 million RM 40.5 million y0.36Proportion of investment 63% 58% 0.44Offer price RM 1.45 RM 1.73 y1.22

URelative offer price 56% 69% y1.80

a t-test of difference between means.U

10% significance level.


favourable times compared to RM 106.1 million otherwise. By segregating thetotal amount raised by investment purpose and repayment of bank borrowing, wefind no significant differences between the two samples. On average, about RM51.8 million was raised for investment purpose under falling term premiums asagainst RM 67.2 million under contrary conditions. An average of RM 33.8million was used to reduce bank borrowing during favourable conditions com-pared to RM 40.5 million otherwise. Relative size of issue measured by theproportion of new shares issued to amount of existing shares were 103% and 69%,respectively for favourable and unfavourable conditions, which are also notsignificantly different from each other. The only marginally significant differenceobserved is for relative offer prices, which were 56% and 69% for the favourableand unfavourable conditions indicating that rights issues are priced lower duringfavourable times. This could be one of the contributing factors for the betterresponse to rights announcements during favourable economic conditions asshareholders get most value. However, the corresponding average offer prices ofRM 1.45 and RM 1.73 are not significantly different.

From the comparisons made of the characteristics of the two samples ofuncontaminated rights issues, it can be concluded that differences in economicconditions reflect availability of more profitable investment opportunities, and thusincreasing equity issuance through rights offerings. However, these conditions donot favour any particular type of companies as no significant differences betweenfirm and issue specific characteristics can be observed.

5.2. Regression analysis

Table 4 summarizes the results of the multiple regression tests aimed atexplaining the behavior of stock returns at announcement time. Five separateregressions were carried out. The first shows the effect of firm-specific variableson price behavior at announcement time. The second incorporates the effect ofstock market behavior and the third includes macroeconomic conditions onannouncement day returns. In the fourth regression, outliers were removed, andfinally in the fifth regression White’s consistent covariance matrix estimators wereobtained to correct unknown form of heteroscedasticity. 15

The regressions run were:

CARAD saqb ROA qb TOBINQ qb ROFFER qb RINVi 1 i 2 i 3 i 4 i

qb LVOL qb SDAR qm , 9Ž .5 i 6 i I

CARAD sa qb 2 ROA qb 2 TOBINQ qb 2 ROFFER qb 2 RINVi 2 1 i 2 i 3 i 4 i

qb 2 LVOL qb 2 SDAR qb 2 MRUNUP qm2 , 10Ž .5 i 6 i 7 i I

15 Ž .Refer to Gujarati, 1995, p. 382 .

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N.Salam

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acific-Basin

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Journal71999

405–

427422

Table 4Regression analysis of announcement period abnormal returns

Ž . Ž . Ž . Ž . Ž .Sample equations Ns72 9 Ns72 10 Ns72 11 Ns68 12 Ns68 13

Ž . Ž . Ž . Ž . Ž .Intercept 0.117 0.62 0.104 0.54 y0.004 y0.02 y0.10 y0.69 y0.10 y0.76

CoefficientsŽ . Ž . Ž . Ž . Ž .ROA 0.098 0.91 0.094 0.86 0.118 1.15 0.106 1.36 0.106 1.54

U UŽ . Ž . Ž . Ž . Ž .TOBINQ 0.002 0.19 0.0014 0.18 0.008 1.04 0.010 1.70 0.010 1.91Ž . Ž . Ž . Ž . Ž .ROFFER y0.047 y1.08 y0.047 y1.07 y0.004 y0.10 0.002 0.06 0.002 0.09Ž . Ž . Ž . Ž . Ž .RINV y0.002 y0.52 y0.002 y0.49 y0.0009 y0.22 0.0009 0.30 0.0009 0.32Ž . Ž . Ž . Ž . Ž .LVOL y0.006 y0.56 y0.005 y0.48 y0.004 y0.43 y0.0002 y0.02 y0.0002 y0.03Ž . Ž . Ž . Ž . Ž .SDAR 1.379 1.38 1.316 1.29 0.958 1.00 0.652 0.84 0.652 0.72

UŽ . Ž . Ž . Ž .MRUNUP – 0.037 0.35 0.074 0.74 0.129 1.56 0.129 1.70UUU UUU UUUŽ . Ž . Ž .ECON – – 0.077 3.15 0.081 4.22 0.081 3.72

2Adjusted R y0.014 y0.028 0.097 0.229 0.229aDw 2.02 2.00 1.92 1.91 1.91

Heteroscedasticity testscB-P-G test 3.111 3.242 3.438 13.401 13.401

Harvey test 10.853 9.895 10.892 9.477 9.477Glejser test 8.085 8.447 10.718 12.530 12.530

dLM 0.39 0.43 2.34 2.49 2.49

t-statistics in parentheses. 1-tailed significance levels: U 10%; UU 5%; UUU 1%.a Durbin–Watson statistic is used for detecting serial correlation.b Predicted value of dependent variable.c Breusch–Pagan–Godfrey test.d LaGrange Multiplier is a measure for White’s general heteroscedasticity test.


CARAD sa 3 qb 3ROA qb 3TOBINQ qb 3ROFFER qb 3RINVi 1 i 2 i 3 i 4 i

qb 3LVOL qb 3SDAR qb 3MRUNUP qb 3ECON qm3 ,5 i 6 i 7 i 8 i I

11Ž .

Same as 11 above with outliers removed, 12Ž . Ž .Same as 12 but reports White’s heteroscedasticity-consistentŽ .

covariance estimators, 13Ž .where the a s and b s are the intercepts and coefficients in the regressions.

Explanation of terms used in the regression:Dependent variable is the 10 days cumulative return upon rights issue an-nouncement over y8 to q1 denoted by CARAD.Independent variables are:

ROA: gross profits divided by total assets,Ž .TOBINQ: market value of equity plus book value of debt divided by book

value of total assets,ROFFER: ratio of offer price to average 20 days pre-announcement price,RINV: relative investment given by ratio of funds allocated for investmentand working capital purposes to gross amount of funds raised,LVOL: gross amount of funds raised at offering, in logarithmic specification,SDAR: standard deviation of residual returns over 60 days before announce-ment of rights issue,MRUNUP: 60 days pre-announcement market returns, andECON: a dichotomous variable, which takes on the value 1 for issues madeduring periods of declining risk premium and 0 otherwise.

None of the variables is significant in the results from regressions shown underŽ . Ž .Eqs. 9 and 10 . Growth opportunities as proxied by the Tobin’s q ratio and

return on assets are in the hypothesized direction but not statistically significant.The coefficient for relative investment is of the wrong sign and not significant.Proxies for information asymmetry, relative offer price and standard deviation ofabnormal returns are also not significant. The coefficient of relative offer price isas hypothesized, but not for standard deviation of abnormal returns which shows apositive relationship. Although the latter relationship is not significant, it gives anindication of the preference of investors for risky issues. Thus, the greater theex-ante uncertainty, the higher the announcement day return. Volume of issue,which proxies for price pressure hypothesis, is in the right direction but is also notsignificant. The same is observed for the state of the stock market as measured byresidual returns of the market index in the pre-announcement period: this is

Ž .consistent with the finding of Masulis and Korwar 1986 , which is significant.Ž .The incorporation of economic influence in Eq. 11 increases the explanatory

power of the regression. Economic influence exerts a significant positive relation-ship on announcement returns of rights issues during falling term premiums. The


coefficient for economic conditions is 0.77, significant at 0.01 level. It indicatesthat issues announced during periods of falling term premiums are better receivedby investors resulting in positive price reaction.

Demand for rights issues during periods of falling term premiums supports thegood news hypothesis that firms have investment opportunities, which requirefinancing through rights issues. In fact, rights issues announced in periods offalling term premiums experience average abnormal return of 7.7% higher than theones announced during rising premiums, after controlling for firm and issuespecific characteristics and market conditions.

The percentage variation in the dependent variable explained by the indepen-dent variables as measured by the adjusted R2 shows considerable improvementwith the addition of the dummy variable to measure economic condition. The

2 Ž . Ž .adjusted R increases from 1.40% for Eq. 9 to 9.7% for Eq. 11 .The analysis is further continued to detect outliers that may have exerted overly

large influence on the overall regression. Observations with studentised residualslarger than 2.0 were deleted. Four such observations were found, reducing the

Ž .sample size in this regression to 68: the result is given in under Eq. 13 . Thecoefficients of the trimmed sample are quite stable except for relative offer prices,which become positive but are still insignificant. The sign for relative investmentalso changed being consistent with the hypothesized direction, even though itremains insignificant. The coefficient for Tobin’s q ratio improves considerablyfrom 0.008 to 0.010, the t-value becoming marginally significant at 0.10. Theadjusted R2 also increases from 9.7% to 22.9%.

White’s general heteroscedasticity test as given by the LM ratio is used to testthe null hypothesis that the residuals have constant variance. The ratios arecompared against the critical chi-square value of 3.84 at 0.05 confidence level:none were rejected as heteroscedastic. Thus, the residuals in the model do notexhibit heteroscedasticity. Nonetheless, White’s heteroscedasticity consistent co-

Ž .variance matrix estimators are reported in regression 13 for comparison purpose.Ž .The results do not differ significantly from those in regression 12 . Only the

coefficient on market run-up improves and becomes marginally significant at 0.10level. This is due to a reduction in the standard error of the coefficient, thusincreasing the t-statistic, although the value of the coefficient itself does notchange.

Overall, the explanatory power of the regression is not very high. This could bedue to the small sample size or insufficient cross-sectional dispersion in the data.However, the low explanatory power is consistent with previous findings eventhough they employed a much larger sample size. For example, Bayless and

Ž . 2Chaplinsky 1996 obtained adjusted R between 2 to 7% for equity issues madeŽ .during hot and cold volume periods. Asquith and Mullins 1986 found the

explanatory power of their model to be between 1.6 to 10.5%. In general, multipleregression to explain the announcement effect of equity issue has not been quitesuccessful as gauged by the measurement of adjusted R2.


6. Conclusions

The findings in this study demonstrate quite clearly that announcements ofrights issues exhibit different price responses under different economic conditions.The announcement period cumulative abnormal return measured over event datesy8 to q1 is 2.99%, significantly positive at 0.05 level. The positive response isattributed to issues made during favourable economic conditions being character-

Ž . Ž .ized by periods of falling term premiums is indicative of a lower issue costs, bŽ .lower dilution of shareholding and c higher funds being raised. On event return

Žduring favourable economic condition is significantly positive t value being large.enough to accept at 0.05 acceptance level at 3.45% positive. The corresponding

number for the unfavourable period is y3.04%, statistically significant butŽ .negative. The two means over the pre-announcement period y60 and y1 differ

Ž .significantly from one another by 11.10% and 5.05% over y60 and y9 days ,with higher announcement period returns registered for the issues in the favourableeconomic periods.

Possible reasons for such discrepancy in results were investigated. Rights issuesmade during favourable and unfavourable economic conditions do not differsignificantly in terms of average values of firms and issue specific characteristics.The only difference is in the total number of issues made: significantly moreissues were being made when conditions are favourable, which is an expectedresult. Findings support the good news hypothesis that investors perceive rightsissues made in periods of falling term premiums as having better prospectscompared to those made when term premiums are rising. These also support thehypothesis that more investment opportunities are perhaps available during suchconditions, which coincide with the expansionary phase of the business cycle. Thepersistent decline in the abnormal returns in the periods following the announce-ments, though not significant, is also consistent with lack of buying interests in athin market, where the absence of investor interest may have led to persistentnegative returns in the post-announcement periods.

Acknowledgements

Ž .We thank the a organizers of the PACAPrFMA 1998 Kuala Lumpur confer-Ž .ence for choosing this paper for publication in the Journal and b anonymous

reviewer of the article for very useful comments. The Universiti Teknologi MARAprovided financial support for this study and granted study leave to Norhana toconduct this research. For any remaining errors, we take collective responsibility.

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Economic influence on rights issue announcement behavior in Malaysia

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