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INSEAD Working Paper 2016/22/FIN
When companies raise equity finance they have to make two choices: the issuing method (cash versus rights) and, when they choose the rights issue method, whether rights should be traded or not. We study these choices using a sample of 15,751 rights issues and 22,016 cash offers announced during 1995-2011 in 127 countries. To explain these choices we consider three hypotheses: the adverse selection hypothesis, the control hypothesis and the financial distress hypothesis. The general conclusion is that none of these theories by themselves can fully explain what we observe.
However, we clearly reject the most popular explanation in the literature, i.e. the adverse selection hypothesis, as both rights issues and cash offers are followed by long-term negative excess returns. When we examine the second choice, i.e. the choice to have tradable rights, we find that in the short run the market appreciates the fact that rights are not trading, but in the long run firms with non-tradable rights underperform. In fact, firms seem to restrict rights trading in order to raise financing when the prospect of restructuring is more doubtful and the need to force the hand of the existing shareholders is higher. This provides additional support for the hypothesis that many rights issues are made by firms in financial distress.