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Rights issue related discounts in France, Germany, Switzerland, and the United Kingdom

Various empirical approaches

Diplomarbeit 2008 128 Seiten

BWL - Recht






List of figures

List of tables

List of abbreviations

0 Introduction
0.1 Objectives, motivation and focus
0.2 Theoretical approach, methods and structure

1 Equity capital markets - raising shareholders’ equity
1.1 The function of equity capital markets - an introduction
1.2 History of equity capital markets
1.3 Equity capital markets today
1.3.1 Interaction of relevant market players Listed public companies Role of banks and ECM-departments Role and types of investors
1.3.2 Economic relevance and situation of today’s equity capital markets
1.4 Rights issues in the context of different types of equity offerings
1.5 Price determination and underwriting models
1.6 Rights issues - offering new shares with pre-emptive rights
1.6.1 Rationale for rights issues
1.6.2 Historic development and mannerism of rights issues
1.6.3 Importance of rights issues today
1.6.4 Current legal framework France Germany Switzerland United Kingdom Summary of main differences in legal frameworks
1.7 Summary

2 Review of financing theories and empirical evidence
2.1 Modern theories of optimal financing
2.1.1 Theoretical ex-rights price and value of pre-emptive rights
2.1.2 Modigliani-Miller theory of capital-structure irrelevance
2.1.3 Trade-off-theory of optimal financial leverage
2.1.4 Pecking order theory and corporate financial behaviour
2.1.5 Principal-agency theories of optimal capital structure
2.1.6 Financing theory impact on rights issues
2.2 Impact of seasoned equity offerings - a review of empirical results
2.2.1 Accounting quality
2.2.2 Costs, underwritings effects and flotation method choice
2.2.3 Debt preference due to moral hazard, leverage and equity ratio
2.2.4 Deeply discounted issues
2.2.5 Free-cash-flow
2.2.6 Free float, trading volume, volatility and share type
2.2.7 Industry sector and growth
2.2.8 Pre-announcement share price performance
2.2.9 Shareholder structure
2.2.10 Size of issue
2.2.11 Size of issuer
2.2.12 Supply increase
2.2.13 Tax reductions on the shareholder’s level
2.2.14 Transparency effects and marketing effects
2.2.15 Firm valuation and management incentivising
2.3 Specific impacts of rights issue variables
2.3.1 Deep discounts
2.3.2 Number of previous rights issues
2.3.3 Rights issues vs. public placings
2.3.4 Rights trading
2.3.5 Take-up ratio
2.4 Country specific impact
2.4.1 Specific impact of rights issues in France
2.4.2 Specific impact of rights issues in Germany
2.4.3 Specific impact of rights issues in Switzerland
2.4.4 Specific impact of rights issues in the United Kingdom
2.5 Summary of financing theories and empirical results

3 Survey of rights issues in CHE, DEU, FRA and GBR
3.1 Research design and methodology
3.1.1 Presumptions and data collection
3.1.2 Calculation of abnormal returns
3.1.3 Hypothesis development
3.1.4 Descriptive statistics and hypotheses tests
3.2 Sample selection
3.3 Descriptive statistics
3.4 Hypothesis development
3.5 Empirical results
3.5.1 H1 - Positive performance of growth industries
3.5.2 H2 - Positive correlation of P/E ratios
3.5.3 H3 - Negative correlation of discounts
3.5.4 H4 - Positive correlation of debt ratios
3.5.5 H5 - Negative correlation of free floats
3.5.6 H6 - Negative correlation of market capitalisations
3.6 Conclusions

4 Summary and concluding remarks

5 Appendices


This work primarily focuses on share price reactions resulting from rights issues in France, Germany, Switzerland, and the United Kingdom. Using a sample of 417 rights issues between 2000 and 2008 this study confirms earlier evidence that UK rights issue announcements exhibit a significant abnormal negative impact with an average of -2.51%. With a loss of with an average of -1.52% French rights issues had a clear abnormal negative impact, which, however, was lower than that of the UK. In contrast to these findings the recent rights issues in Germany and Switzer- land showed with an average impact of -0.67% and -0.04% no strong negative effect. However, the slightly negative effect of rights issue announcements in Germany and Switzerland clearly differs from earlier studies that that have reported abnormal positive effects. Therefore, the present results confirm predictions of a further equalisation of announcement effects initiated by the harmonisation of equity markets (including the elimination of tax advantages in Switzerland) and legal settings. Furthermore, this study in essence confirms the hypotheses of a positive correlation of debt ratio and of a negative correlation of discount for all four countries. In contrast, neither a clear correlation between announcement effects and P/E ratios nor more positive abnormal returns of announcement effects for rights issues in growth industries could be verified. Finally, no correlations between free float or market capitalisation or abnormal announcement returns have been found.

Journal of Economic classification (JEL): G14, G32, K22, D80 Library of Congress Classification (LCC): HF 5681.S85 European Business Schools Library Group (EBSLG): 220Q Keywords: Rights issues, seasoned equity offerings, share price discounts, valuation effects, conditional event study, equity capital markets


This thesis would not have been possible without the great support of many people sharing information, motivating, discussing with and correcting me. Firstly, I would like to thank Dr. Jörg Schröder, Thomas Wohlgefahrt and Corinna Draga of the Equity Capital Markets team from HSBC Trinkaus & Burkhardt AG for allowing me to write this thesis in connection with a great internship in their department. Their comments and especially the usage of their data systems were an integral basis for all included analyses. Many thanks as well to Corinna Voglis from the HSBC Global Asset Management who strongly motivated me to write my thesis with HSBC and to whom I owe the first amazing experiences in investment banking during the summer of 2007. Secondly, I am deeply grateful to my examiners, Prof. Dr. Karl- Wilhelm Müller-Siebers and Prof. Dr. Marc Oliver Opresnik, both from the FHDW Hannover, for supporting this thesis from the academic perspective and for many extremely useful comments. Thirdly, I would very much like to express my sincere thanks to Dr. Barbara Böhnlein from ABN AMRO Bank N.V. She was the first to introduce the equity capital markets mechanism to me during my internship in the spring of 2007 and had a strong impact on both, the topic and the contents of this thesis. I owe her many exiting insights, discussions, comments, and answers and I very much enjoyed working with her. Furthermore, I would like to thank all other authors, institutions, experts, colleagues and friends who provided their papers and comments and who very openly and kindly answered all my questions. I would like to especially thank Dr. Michael Schlitt and Dr. Susanne Schäfer from Willkie Farr & Gallagher LLP, Martina Wirz from Baker & McKenzie, Zurich, Andrew Robinson from the ECM Syndicate of HSBC Bank plc, London, and Yama Akbar from Attorney at Law - Partner in France for their great support concerning legal frames for rights issues. I am also very grateful for the continuous linguistic support by Britta Meyer.

Last but not least, I would like to thank all my friends we motivated me and showed a strong understanding that this thesis claimed most of my free time during the last months. However, my heartfelt thanks go to my parents and my sister whom I owe more than I can couch in words. This thesis is dedicated to them with deep gratitude.

Bastian Bahnemann, October 2008

List of figures

Figure 1: Development of the number of German listed companies 1886 - 2008

Figure 2: Global development of the number of public companies

Figure 3: Development of major global stock indices 2006 - 2008

Figure 4: Recent development of initial public offerings

Figure 5: Recent development of follow-on offerings

Figure 6: No of listed stock companies in FGSU

Figure 7: The different types of equity offerings

Figure 8: Issuing methods and underwriting models

Figure 9: Global importance of rights issues and ABBs (2007 - Sep 2008)

Figure 10: Follow-on offerings in Europe 2007 - August 14th, 2008

Figure 11: Development of rights issues in contrast to other follow-on offerings

Figure 12: Abnormal announcement effects by year

Figure 13: Distribution of abnormal announcement effects

Figure 14: Correlation of P/E ratio (Swiss sample)

Figure 15: Correlation of P/E ratio (German sample)

Figure 16: Correlation of discounts (total sample)

Figure 17: Correlation of discounts (UK sample)

Figure 18: Correlation of discounts (German sample)

Figure 19: Correlation of debt ratio (Swiss sample)

Figure 20: Correlation of free float (total sample)

Figure 21: Correlation of market capitalisation (French sample)

Figure 22: Correlation of discounts (Swiss sample)

Figure 23: Correlation of discounts (French sample)

Figure 24: Correlation of debt ratio (total sample)

Figure 25: Correlation of debt ratio (German sample)

Figure 26: Correlation of debt ratio (French sample)

Figure 27: Correlation of debt ratio (UK sample)

Figure 28: Correlation of free float (Swiss sample)

Figure 29: Correlation of free float (German sample)

Figure 30: Correlation of free float (French sample)

Figure 31: Correlation of free float (UK sample)

Figure 32: Correlation of market capitalisation (Swiss sample)

Figure 33: Correlation of market capitalisation (German sample)

Figure 34: Correlation of market capitalisation (UK sample)

Figure 35: Correlation of P/E ratio (total sample)

Figure 36: Correlation of P/E ratio (French sample)

Figure 37: Correlation of P/E ratio (UK sample)

List of tables

Table 1: Categorisation of correlation coefficient characteristics

Table 2: Average and median abnormal returns by industry sector

Table 3: Quartiles of the t-distribution (v=no of degrees of freedom)

Table 4: Final sample of French rights issues 2000 - 2007

Table 5: Final sample of German rights issues 2005 - 2008

Table 6: Final sample of Swiss rights issues 2000 - 2008

Table 7: Final sample of UK rights issue 2000 - 2008

List of abbreviations

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0 Introduction

0.1 Objectives, motivation and focus

Seasoned equity offerings, also called capital increases1, present a very important source of raising money for listed companies. There are various methods of raising capital via capital increases such as hybrids (i.e., convertible bonds), plain vanilla rights issues, open offers, private placings, and issues without pre-emptive rights. In order to avoid dilution for shareholders, public companies in most European countries are often forced to increase capital via rights issues. Therefore, and due to European Union harmonisation of legislation, rights issues are very important funding sources in France, Germany, Switzerland, and the United Kingdom, each having country-specific characteristics.

In order to choose the right transaction type, the legal requirements as well as the expected market reaction following the capital increase are among the factors for the decision of issuers whether to consider equity offerings. Other factors that influence their decisions are transaction costs, the costs of capital, and placing conditions. Shareholders concerns to prevent any negative share price develop- ment are thus self-evident.

For investment banks being capital market experts and major advisors to the companies, good service becomes more and more important, as there is an enormous international competition with other banks. The share price is a very important value showing how the capital markets respond to companies’ decisions, i.e., the after announcement and after effective emission share price is an important benchmark for good or bad advice concerning the issue. Therefore, the correlation between issue type, structure, industry sector, and share price is an important factor to be analysed by investment banks in order to be able to better evaluate the equity capital markets reactions and to better advise their customers.

For all stakeholders the expected share price reactions are very important and therefore they all constantly demand new expertise in this research area. When analysing event-related share price reactions, there are four major dates and time schedules, respectively, to look for:

1. What effect does the announcement of a capital increase have?
2. What is the development of the average share price performance between announcement and effective issuing date?
3. How does the share price react during the offer period?
4. What is the after-issuing share price performance?

Various empiric analysis methods exist that determine the impact of capital increases on share prices, especially for the US and the UK based upon these four questions. However, only a very limited number of empirical analyses determine the impact of equity offerings in Germany, France and Switzerland with none of them comparing the results with the ones obtained for the UK. Additionally, the identification of country specific reasons for different market reactions on seasoned equity offerings will be important for the respective issuance decisions, and has hence been identified as an important issue for future research2. Therefore, the following comparison between different countries is expected to provide more answers to questions of companies, shareholders and investment banks.

0.2 Theoretical approach, methods and structure

Following a short introduction, chapter 1 provides an overview on developments of public companies and equity capital markets (cf. part 1.2). Before discussing rights issues in a wider context of different equity offering types in part 1.4, part 1.3 describes recent developments and the current market environment of equity capital markets. The short discussion of important issuing methods for underwriting models (part 1.5) leads to the detailed description of the rights issuing concept in part 1.6. A comparison of the different legal frameworks existing in France, Ger- many, Switzerland, and the United Kingdom is important in order to be able to discuss any impact of these differences.

Chapter 2 provides a review of available financing theories and of the related empirical evidence, mostly developed during the last two decades. Following the discussion of the related theories of optimal financing (cf. part 2.1), previously reported empirical observations will be presented and discussed in parts 2.2, 2.3 and 2.4.

The central part of this thesis is presented in chapter 3, starting with the model description and hypothesis derivation in part 3.1. Thereafter, the data sources and the selection methods of underlying samples of this study are given in part 3.2. The core of this chapter, i.e., parts 3.3 and 3.5, contain the descriptive and empirical evidence and its analyses. In the first section, the descriptive analysis shows the results that can be directly derived from the underlying samples. In the following sections, correlation analyses will proof the previously drawn hypotheses compar- ing different countries. All results are summarised in the last part of this chapter, i.e., in the conclusion section.

Finally, chapter 4 contains general conclusions and future prospects, thus rounding off this essay.

The appendices including an annex directory, all references and sources used in this thesis, and the required declaration of honour can be found in chapter 5.

1 Equity capital markets - raising shareholders’ equity

In the following an overview will be given on the functions, history, and specific characteristics of equity capital markets, equity offering types, flotation methods, and rights issues in particular. A general introduction into the world of equity capital markets is presented in part 1.1. For a better understanding of today ’ s equity capital markets (ECM) part 1.2 then describes the historic development of public companies and equity markets. The current economic relevance of these markets is discussed in part 1.3 before part 1.4 illustrates the offering type “ rights issue ” in comparison to others. Different flotation methods and various underwriting models form the content of part 1.5. These different methods and models are used as the basis of the main part of this chapter, Part 1.6, which explains function, history, and legal aspects of rights issues and pre-emptive rights in detail. A short chapter summary (part 1.7) then concludes this chapter.

1.1 The function of equity capital markets - an introduction

The terminology “equity capital markets” implies two meanings: The global equity markets in general and the departments in universal and investment banks that deal with equity financing of corporate clients. As this paper focuses on capital market reactions, the term “equity capital markets” will mainly be used to describe the equity markets themselves.

Equity markets are organised markets that trade shareholders’ equity. Companies employ equity markets to raise additional capital through the offering of new shares3. Existing shareholders utilise equity markets to value their stake and to enlarge or to decrease it by buying or selling shares. New investors use equity markets to invest in listed companies while benefitting from high transparency rules and liquid markets that subsequently allow them to sell their stakes again. Appar- ently, banks, unless acting as investors themselves, seem to play no major role in this equity financing model besides routing equity orders from investors to ex- changes. However, in particular due to this routing function and since they are the major debt capital financiers for companies as well as for investors, banks are established as very important brokers between companies and investors. Especially when companies or shareholders try to sell large amounts of (new) shares via public or non-public equity offerings, banks play an important role coordinating the issuing process, connecting old and new investors, and setting up the issuing price as well as the required regulatory framework.

1.2 History of equity capital markets

The historic roots of equity capital markets can be traced back to the Roman Empire where traders formed groups to finance cargo vessels4. While these activities used to be limited until the end of the trading trip, businessmen formed unions to pre-finance long-term mine and exploration projects during the 12th century. Two hundred years later, these unions started to expand their shareholder basis to investors from other industries that were also able to buy smaller stakes. In the 12th century, the first predecessors of stock exchanges developed when traders started to meet periodically to exchange goods and currencies.

More direct roots of modern equity capital markets can be found in the beginning of the 15th and 17th century, when the first stock exchanges and the first joint stock corporations were founded.

Netherlands city of Brügge was the first to establish an official exchange in 1409 with France (Lyon) and Germany (Augsburg and Nürnberg) following around 1540. These exchanges started with trading goods and currencies. Later, in the 17th century, they also started trading shares of the newly established joint stock corporations.

The first world-wide joint stock company was the British trading company Honour- able East India Company (HEIC), which was founded in 16005. With an initial capital of GBP 72,000 and 125 shareholders (all influential businessmen), the company was an important predecessor for modern corporations. The characteris- tic of a joint stock company is that the business risk is restricted to an underlying amount of money and that the business entity is held by at least two owners. These divide their business stake through issued certificates6. With this division of company ownership financial risk and participation in company’s profits are also split.

Globally, the first joint stock company offering shares to the public was the Nether- land Verenigde oostindische Compagnie (V.O.C.)7, a trading company for spices, especially known for trading pepper8. It was established in 1602 by Johan von Oldenbarnevelt and was the first company which started to publically issue shares as “actie” via the Amsterdam Stock Exchange following its establishment in 1612. V.O.C. was the first company in which not only private businessmen were share- holders. Also cities und other private investors were allowed to invest while limiting the financial risk to a nominal amount of shares. Therefore, V.O.C. could be named as ancestral public limited company (plc)9.

With the purpose to establish settlements in North America, the Virginia Company of London was the third company to be chartered as joint-stock company on April 10th, 1606 in Great Britain.

The first Prussian or later German joint stock companies were “Brandenburgisch- Ostindische Kompanie”, founded in 1650/5110, and Handels-Company auf den K ü sten von Guinea, founded in March 17th, 1682 by the Prussian king Friedrich Wilhelm, the “Big Elector”. Just like previously founded joint stock companies this one focused on maritime trade as well. Other industry sectors in Germany started to establish public companies after 1765 (Berliner Assekuranz (1765), Private Breslauer Zuckerraffinerie (1770), Hardenbergsche Kohlebergwerke (1840). Thereby, the first common law that regulated companies in general was introduced in Prussia in 179411.

Between 1801 and 1825, sixteen public companies were established with the permission of the Prussian king. The first common French law for public compa- nies, the “Code de Commerce” (CdC), was established in 180712. Although this law had only twelve articles that defined and regulated the “société anonyme”, this law was globally the first common codification that regulated public companies. Because French laws were especially relevant in the Rhineland, one can say, that this law is also the first “German” law. This French Code de Commerce had considerable impact due to the strong influence of Napoleon Bonaparte at that time, but is was also used as blueprint for many subsequently established laws including the regulations of many Swiss cantons and in the Netherlands13. The Netherlands introduced in 1838 their public company law “Wetboek van Koophan- del”, that used CdC as blueprint but added many new aspects. This regulation of the Netherlands was also the major blueprint for subsequently established first Prussian public company law in 184314.

In 1850, around 130 public companies had been established in Prussia, increasing to 425 in 1870. Banks were allowed to charter as public companies following a new stock corporation law in June 11th, 187015, but the first company in this industry sector was already chartered in 184816. Alongside large capital requirements due to colonialism and big mining activities, the growing railway industry in the 19th century formed one important driver for the development of public companies in the former Prussia17.

During the second half of the 19th century, with an increasing number of stock exchanges, more and more countries started to develop special laws for the regulation of these stock exchanges and to exchange trading. At the same time it became easier to establish public companies, with the result that the number of public companies rose dynamically. More than 850 public companies were founded in Prussia between 1870 and 1874 alone18. Simultaneously, the number of companies that were liquidated also increased, so that governments started to establish laws to improve shareholders protection.

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Figure 1: Development of the number of German listed companies 1886 - 200819

As Figures 1 and 2 show, the overall number of listed public companies increased continuously over the years with special developments in single countries due to the respective economic and political factors. One example for this is the drop in number caused by the economic crises in the 1920’s and by the 2nd world war, shown impressively in the first chart (cf. Figure 1).

The first years of the 20th century were characterised by many countries adopting public company and exchange laws, adjusting shareholder’s rights and protection individually and drawing the laws in legal statutes. Major drivers for the latter development were the world economic crisis from 1929 to 1931 and the spectacu- lar stock exchange crash in New York on October 24th, 192920. Important changes in these years include the announcement of restrictions for public companies to buy own shares and to decrease share capital21.

Nevertheless, following some major enlargements of shareholder protection rights at that time, most stock corporation laws have not been changed fundamentally as the comparison of current and old German public law from 1937 shows explicitly. The middle of the 20th century therefore was mostly dominated by legal adjust- ments to adopt rules to newly established financial market products, especially derivatives. Due to the political formation of the European Union, a harmonisation process of European laws regarding public companies started in the 80s and 90s of the last century changing many details in the laws of several countries.

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Figure 2: Global development of the number of public companies22

The beginning of the 21st century was dominated by the global establishments of many new transparency standards and corporate governance rules that have been introduced since 2001 due to high-profile collapses of some large US-firms including Enron and Worldcom23. These transparency standards and new regulations regarding shareholders acting in concert are the topics that still dominate the discussion about modern public company laws.

1.3 Equity capital markets today

1.3.1 Interaction of relevant market players

While public companies try to minimise the costs of capital directly payable in form of dividends or indirectly as voting power and issuance of “cheap” shares, the investors often seem to aim for the opposite when trying to maximise their invest- ment interests. Anyway, in perfect markets that discount any future values to present value, there should be no difference in shareholders’ and companies’ objectives. However, as both parties have often different views on decisions and as future gains are usually not completely discounted to present value, these two parties are not always in line.

Consequently, investment banks as advisors and brokers between companies and investors would not be required in perfect markets with full information symmetry where they might simply be regarded as undesirable cost factors by the other parties. However, as there is still a lot of information asymmetry between compa- nies and investors and as a lot of companies lack the knowledge concerning equity capital market practices, investment banks are actually required by both parties. Thereby the ultimate aim of these banks is to gain profits and positive reputation. The result is, that a bank always tries to maximise its fees while minimising its risks during a transaction. This may be problematic as, in contrast to investors and companies, banks have only a small indirect interest in the positive future perform- ance of a company. To obtain a better overview concerning the specific interests of the three parties, their roles will be described in more detail below. Listed public companies

Listed public companies are joint stock companies with part or all of their outstanding share capital listed on an exchange that trades their shares. The main reason for a company to go public24 is often the possibility to raise shareholders’ equity to finance the business. When issuing new shares, which means that the company offers young shares to old or new investors (called primary offering), the company raises additional equity cash to finance its business.

On the other hand, a public listing is a common way for existing investors to sell their stake in the company or parts of it to exit the company. In these transaction types called secondary offerings already existing shares are sold, so that the company itself will receive no additional funds from the sale. Public listings in regulated market segments25 are complicated time- and money-consuming processes that generate ongoing regular costs for listing and disclosure. Therefore, many public offerings are combined offerings that offer primary and secondary shares together.

Furthermore, the big marketing effect of a public listing and the publicity that is connected with an initial listing, are high motivating factors for the management when considering financing alternatives. Additionally, the possibility to incentivise the management and employees with stock options supports this decision because it is widely assumed that these stock options increase productivity. Role of banks and ECM-departments

Mainly three types of banks exist: universal, commercial, and investment banks26. Universal banks are a composition of commercial and investment banking, very common on the European continent. Sole commercial or investment banks can be found in the United States, where they are required to focus on one of these areas following the Banking Act of 193327. Commercial banks present the more traditional form of a bank, i.e., the financial intermediate between borrowers and lenders in money and capital markets. Commercial banks receive funds through saving accounts and issued bonds which provide loans to the customers. Pure investment banks advise and execute mainly the buying and selling of bonds, shares, curren- cies and various derivative products. No matter whether the underlying bank is a universal or a focused investment bank the investment units of these banks act as financial intermediates between companies, investors, and exchanges.

The equity capital market’s (ECM) department in these investment units is an advisory and organising group: It advises companies in all topics connected to equity structuring, listing topics, capital market related financing options, capital market developments, and investor topics. Especially when a company plans the placement of shares to institutional or private investors, ECM acts as an organiser for the whole process including timing28, prospectus drafting, due diligence investi- gations, roadshows between company’s management and (potential) investors, external communications, share registrations, and bank’s risk/financial underwriting commitment to place or buy a certain amount of shares at a certain price29. Furthermore, ECM mainly develops and adjusts the company’s equity story together with the company30. This equity story is the basis for the equity sales department to sell the shares to investors.

As there is normally more than one bank included in larger share placements31, the ECM departments coordinate the placement process often together with these other banks. All together, these banks form a syndicate with normally a two to three layer organisational structure. Depending on the transaction size and the market environment, there are normally one to four banks acting as Lead Managers and Global Coordinators in the top layer of the syndicate. These Lead Managers are responsible for the main process and thus the biggest part of the share placing. The banks in the second or potentially the third row32 are usually responsible for smaller parts of the shares and have no major role in organising the process. Role and types of investors

There are various types of investors that buy shares of a company: Institutional investors, private investors (“retail investors”), insurance companies, hedge funds, sovereign wealth funds and strategic investors. Each investor can have different investing strategies but tries to maximise the profit of its investment.

There are always two ways to invest in a company: direct investment, i.e., buying shares from other shareholders or the company, or indirect investment, i.e., buying shares through a stock exchange. Especially before investing in smaller companies or in an IPO, investors often use the knowledge and advice of banks to obtain information about the companies. Furthermore, the banks market the new shares via their direct access to the investors and therefore initiate meetings with the management (“roadshow”).

1.3.2 Economic relevance and situation of today’s equity capital markets

The recent developments of equity markets were dominated by the sub-prime mortgage crisis (“credit crunch”) that was precipitated with a bursting of the US housing bubble and high default rates on bad rate mortgages in 2007. Due to a series of credit collapses and supported by a slowing of the US economy the crises rose to an international banking crisis after first banks collapsed, while others had to write off big amounts of bad credits and the inter bank lending froze. In Septem- ber 2008 the crisis is still present with the two biggest American mortgage lenders, Fannie Mae and Freddie Mac, just being rescued by the US government that decided to become fully liable for all financial losses33. Parallel to this bank- and credit crisis, all big economies including the US, the UK, Japan, Germany, and France, show a slow-down in economic growth or even strong signs of a real recession in the case of the US economy.

Because of this fundamentally challenging environment, global recession fears and many financial institutions writing off big amounts, the global equity markets showed disappointing performance since the summer of 2007. Figure 3 demon- strates how major indices lost since the summer of 2007 and shows expressively the loss during January 21st and January 23rd, 2008 when the French bank Société Générale had to settle around EUR5bn options that its trader Jérôme Kerviel had taken far beyond his limited authority34.

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Figure 3: Development of major global stock indices 2006 - 200835

This economic development and especially the bad performance and high volatility of equity markets as well as bad outlooks and many fears about further write downs and bad news, had direct impact on primary and secondary equity markets36. In the primary markets for new initial public offerings many planned offerings were cancelled or postponed. Figure 4 shows that primary markets in the four studied countries of this thesis dropped sharply with some quarters showing not even one transaction in some countries.

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Figure 4: Recent development of initial public offerings

The situation of secondary equity markets, on the other hand, appears to be slightly different. Many companies postponed seasoned equity offerings due to declining valuations as far as they were not forced to issue equity. Nevertheless, the num- bers shown in Figure 5 indicate a rising issuing activity. This is mainly caused by mayor financial institutions issuing big follow-on offerings to cover their large write downs37.

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Figure 5: Recent development of follow-on offerings

In spite of these recent negative developments, equity markets are still very important to finance companies. The number of listed joint-stock companies remains on a constantly high level (see Figure 6). Regarding the importance of equity markets the amount of new equity issues should be observed rather than the market capitalisation because the latter value does not consider in- and outflows and depends on variable valuations38. Figures 4 and 5 already showed that especially the first quarter of 2008 was characterised by a declining number of equity offerings. Globally there were again around USD122.9 billion equity offerings announced in Q2 2008 after USD51.2 billion in Q1 2008. Regarding the develop- ment of announced international equity issues the rising amount from USD309 billion in 2005 to USD501 billion in 200739 shows that globally a huge demand and inflow for equity financing still exists.

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Figure 6: No of listed stock companies in FGSU40

In the beginning of September 2008, many equity market experts still expected a rebound of international equity markets in Q4 2008 as well as during the first half of 2009. However, after the financial crises and market tumults came to a head, no economist seems to be able to predict how long this crisis will last and how deep the markets will dip.

Nevertheless, alongside expected and already announced further seasoned equity offerings required by large financial institutions, rebounding equity markets should again make raising equity for listed public companies more attractive. In particular regarding FGSU, the primary market is expected to show some large IPOs. The German solar equipment manufacturer SCHOTT Solar AG with an EUR500m IPO, privatisation IPO of the German railway company “DB Mobility Logistics” (EUR4- 6bn) and the GBP1bn IPO of the British life assurance company “Resolution” are major transactions that are expected to be executed in the primary market of FGSU in the last quarter of 200841.

1.4 Rights issues in the context of different types of equity offerings

Today’s supply of equity offering variants includes a variety of different transaction types. Because there is not one single exact definition for each of these transaction types to be found in the literature, it is difficult to differentiate each one clearly from the others. Even so, to present an overview of the proliferation of variants and to classify rights issues, the following part outlines the presently existing offering types. Figure 7 shows an overview of the different offering types that will be discussed in this section.

As already mentioned in subsection, the source of offered shares is most characteristic to classify the respective equity offering type. All primary offerings exclusively offer young and new registered shares and therefore raise additional cash for the issuer42. Because of that, the amount of outstanding shares after a primary offering is higher than before43. All secondary offerings constitute the opposite type of offerings exclusively using existing, secondary shares with only the selling shareholder receiving the funds. Therefore, the number of outstanding shares does not change after the offering. In IPOs, the issued shares are mostly a combination of both, primary and secondary shares, and therefore offered as a so called combined offering.

Secondly, one can differentiate between initial offerings, which is an issue of a share class, first time listed on an exchange, and follow-on offerings44, that offer shares of already listed companies. It is the biggest difference between these transactions that follow-on offerings can be based on the traded share price and sometimes relies on the existing shareholders. The valuation and first pricing of shares in an IPO is a highly complicated process.

Thirdly, the differentiation between public and private offerings is always very important as it is connected with considerable legal obligations. A public offer has usually the highest requirements for transparency standards. While in Germany shares can be offered to a small group of private investors without drafting an offering prospectus45, such a prospectus is required whenever a company intends to tap a larger group of shareholders.

As shown in Figure 7, one can further distinguish between seasoned and unseasoned offerings. Seasoned equity offerings are a subset of such capital increases including all capital increases with the underlying share class being already listed46. On the contrary, unseasoned equity offerings are equity issues with the underlying share class not being listed. In particular initial public offerings and the first listing of, i.e., preferred shares are unseasoned equity offerings47.

illustration not visible in this excerpt

Figure 7: The different types of equity offerings48

These seasoned equity offerings distinguish between rights issues, open offers and seasoned equity offerings excluding pre-emptive rights 49. The differentiation criterion is the fact whether or not pre-emptive rights for the new shares are offered to existing shareholders. Depending on the specific country regulations an exclusion of pre-emptive rights is usually only allowed if the issuing size is below a certain percentage of the totally existing share capital. This regulation exists in order to protect shareholders as their stake in the company will be diluted when new shares are issued without pre-emptive rights.

A rights issue is an offer that allows existing shareholders to exercise these pre- emption rights to purchase new shares pro-rata for their holdings at a discount in respect to the pre-announcement share price50. Depending on country specific requirements, the shareholders normally have at least a subscription period of two weeks to decide whether to execute their pre-emptive rights, to sell or to let the offer expire. An exchange based trading of pre-emptive rights is not required by the legislation of any country. Nevertheless, the arrangement of exchange trading for pre-emptive rights is common practise to offer shareholders an easy way to sell their rights. If this is not arranged, it will be more difficult for shareholders to sell these rights and therefore the de-facto risk of loosing wealth when deciding not to take up their rights is higher51.

Similar to a rights issue is an open offer. It is an offer that grants existing investors pre-emptive rights pro-rata, but does not allow the shareholders to sell their pre- emptive right in case they are not able or willing to take up the newly issued shares52. In most cases an open offer is executed with a conditional offering to another (potential) investor who agrees upfront to the equity offering to purchase all shares that are not sold via pre-emptive rights. While this offering type has clear disadvantages for investors who do not take-up their pre-emptive rights53, for the company it guaranties a successful placing of all new shares at a previously determined price.

Last but not least, seasoned equity offerings that exclude pre-emptive rights54 are capital increases that grant no pre-emptive rights to existing shareholders. Therefore, the power of the shareholders will be diluted after the closing of the offer or they have to share dividends and voting power with an enlarged number of shareholders. Hence, as already mentioned, many countries have set up rules protecting shareholders against dilution by restricting issues without pre-emptive rights completely or by restricting issues above a certain percentage of outstanding share capital (i.e., >10%)55.

1.5 Price determination and underwriting models

Issuing methods of plain-vanilla rights issues with a take-up ratio of 100% exist in the case that a company sells all new shares to existing shareholders during the subscription period or when all investors that do not take up their subscription rights sell them to other investors. However, there are normally always unsold shares remaining after closing the subscription period, called the “rump”. To place these shares in the market (“rump placement”), a whole range of different issuing and underwriting methods is applicable, although the rump has to be placed at a price close to the current market price56.

Today, in most cases these shares are placed in a plain-vanilla accelerated book- building with underwriting to nominal share price prior to the start of the subscrip- tion period with the agreement that positive placement proceeds will be paid to the issuing company57. This is mainly due to the fact that the new shares, i.e., the global note of the shares58, need to be underwritten first to come into existence. Nevertheless, in the following all common issuing methods and underwriting models will be introduced, also not all are applicable for the rump placement of rights issues. This knowledge is required to be able to define the rights issuing process within the larger environment of equity issues and to evaluate the impact of different process announcements parallel to rights issue announcements concern- ing the share prices.

Pricing59 and underwriting are very important and difficult parts of the issuing process as in many offerings a conflict exists between issuers who are normally interested in a high issuing price60 and investors who try to buy the shares as cheaply as possible61. This situation is especially apparent for companies and investors in SEOs that exclude pre-emptive rights. Furthermore, especially in all underwritten offerings, the banks try to underwrite at the lowest possible price as it minimises their risk62. For rights issues this situation is slightly different. Because shareholders receive pre-emption rights, there is no direct benefit or disadvantage of discounts because in parallel to a higher discount the value of pre-emptive rights rises63. But although there are sometimes tax reasons for high discounting rights issues, in practice, a large discount often signals financial distress to the market because the company desperately searches for new funds64. Nevertheless, the company itself usually tries to maximise its proceeds and therefore often aims at a high issuing price. A bigger number of shares would be the second alternative for the company to maximise the proceeds but this number is often limited due to regulations and shareholders authorisation.

Distinguishing the different currently available issuing methods and underwriting models is very challenging because exact definitions or clear differentiations can hardly be found in the literature. Especially the separation between the different variants of accelerated offerings is a challenging task, as institutional and legal details are unfamiliar to most commentators. Hence, even simple terminology is often not known and official definitions for many issuing methods of today’s practice have not been published65. Therefore, the following paragraphs identify the most important criteria that can be used to differentiate issuing and underwriting types.

In general, for equity placements excluding pre-emptive rights or for rump placements in rights issues, three different issuing methods exist that differ by the way of determining prices and allocating the shares. These are called auction-methods, book-buildings and fixed pricings.

The fixed pricing is one of the oldest ways of selling new equities. The price is ex ante determined by the company which then tries to find investors with the help of the banks. Thereby an allocation first-come-first-gets or a posterior allocation pro- rata after an offering period or due to qualitative criteria is possible. The price is usually calculated by company’s analysis, profit or turnover multiples to list peer companies or related valuation methods66. As this method relies on a very good ex ante price determination it is very inflexible in particular in high volatile markets. Especially the determination of the length of the subscription period of rights issues is difficult with issuers or underwriters facing a high risk not to place all shares because of share price changes during a relatively long subscription period. Therefore, nowadays this selling method only plays a minor role67.

Auction methods are in general auctions in the classical meaning that invite some bidders to bit and then usually sell the shares to the highest bidders. These bidders could be direct, mostly institutional, investors or intermediates/investment banks that only purchase the shares by auction to immediately start reselling them by trying to obtain a higher price. In the letter case one further separates between (US-) block trades and bought deals68 /69. In both issue types a large tranche of shares of one share class70 is usually sold to the highest bidding financial interme- diates that resell the shares as soon as possible to others. Contrary to bought deals, block trades do not include market out-clauses71 and will resell the shares more quickly72.


1 Subject of this thesis are rights issues as one type of capital increases by cash contributions. Share price reactions of capital increases from the company’s own resources that offer bonus shares are not discussed. Therefore, the term “seasoned equity offering” or “capital increase” widely excludes bonus share offerings.

2 Cf. Eckbo et al. (2007) p. 110

3 Cf. Deutsche Börse Group (2008) pp. 41 ff.

4 Cf. Wirtz, B. W. / Salzer, E. (2005) p.17 ff.

5 Extensively known as East India Company but also as East India Trading Company or John Company

6 Common names for these company-certificates include “stock”, “share“, “security“. As the name “stock“ is dominantly used in American English, this paper uses the term “share”.

7 Also known as Dutch East India Company

8 Cf. Raguß, Gerd (2005), p.4 f.

9 The term “public limited company” or “public company” is the British expression for a public joint stock company and therefore used in this paper. Further expressions naming the same kind of company are “ corporation and incorporation, widely used in American English

10 Cf. Bayer, Walter et al. (2007) p. 133

11 Allgemeine Landrecht für die preußischen Staaten (ALR)

12 Cf. Bayer, Walter et al. (2007) p. 24

13 Cf. Bayer, Walter et al. (2007) p. 89

14 Cf. Bayer, Walter et al. (2007) p. 135

15 “Neue Aktiengesetz des Norddeutschen Bundes”

16 Cf. Breitkopf, Thorsten (2006), p.4

17 Cf. Bayer, Walter et al. (2007) pp. 128 ff

18 Cf. Wirtz, B. W. / Salzer, E. (2005) p.20

19 Source: Deutsche Bundesbank, Deutsches Aktieninstitut e.V.; including German AG and KGaA

20 Cf. Bayer, Walter et al. (2007) p. 573

21 Cf. Bayer, Walter et al. (2007) pp. 573 ff

22 Source: Own summary, data from The World Federation of Exchanges

23 Most important change with introduction of the Sarbanes-Oxlay Act in 2002

24 Initial public offering or going public express this process

25 Most stock exchanges have unregulated and regulated market segments with different (transparency) requirements that are defined by government laws. Additional sub-segments like German “Prime Standard” or “DAX” are segments that have even higher standards than law requires that are set up by each exchange itself to allow the companies to differentiate

26 In later sections of this thesis the term „investment bank“ also includes universal banks that have the according investment branches

27 Glass-Seagall Act

28 There is considerable discussion whether companies try to time their equity issuances. It is obvious, that one always tries to adjust the timing to previously known market events like the publishing of important economic indicators. Furthermore, the general timing of equity offerings often depends on the share price development (cf. part 2.2). Thereby the degree of timing seems to vary between different offering methods (cf. Burch, Timothy R. et al. (2004) p.5)

29 Cf. Eckbo, B. Espen (2007) pp. 11 ff

30 When preparing follow-on offerings a clear equity story usually already exists. Nevertheless, one also should evaluate this equity story prior to any follow-on transaction to underline the key selling arguments.

31 Follow-on equity offerings less of than 10% of the outstanding share capital are usually coordinated by just one bank.

32 Co-Lead-Managers

33 Cf. Financial Times (2008/09/08) US takes control of Fannie and Freddie

34 Cf. Financial Times (2008/01/24) SocGen uncovers €5bn fraud

35 Source: Bloomberg per 2008/09/09

36 The “primary market” is the part of the capital market that includes the issuance of new registered shares. The part that includes all securities that have already been issued is called “secondary markets”.

37 Including large rights offer of Royal Bank of Scotland’s (EUR15.4bn), UBS (EUR10bn), HBOS (EUR5.2bn), Barclays (EUR5bn), Societe Generale (EUR5.5bn), Credit Agricole (EUR2.7bn) and an EUR1bn accelerated bookbuilding of Commerzbank; source: Dealogic

38 Cf. United Nations conference on trade and development, Geneva: Trade and development report 2008 p. 93

39 Cf. Bank for International Settlements ("BIS"), Quarterly Review, September 2008, Table 18: Announced international equity issues

40 Data from Deutsches Aktieninstitut; data for France not available since 2001

41 Cf. Thomson Reuters (2008/09/10)

42 Aside from bonus share offerings (also called capitalised issues) that offer shareholders additional free shares that are paid out of the company’s reserves. As this special case has neither an impact on shareholder structure nor on company’s financial structure this thesis will not further mention bonus shares.

43 Cf. Ho, Yueh-Fang (2003) p. 67

44 Sometimes also called „subsequent transactions“

45 Instead of “offering prospectus” the terms “offering memorandum” or “offering circular” sometimes are used synonymously. But the first describes a legal document that usually has to be approved by a financial authority while letters commonly are used when a registration is not required (the volume of letters is usually significantly smaller as well). Nevertheless, both are legal documents that can form the basis for legal settlements.

46 Cf. China Daily (2006/04/15)

47 Because there is no reference share price, the pricing of unseasoned equity offerings is more difficult compared to the pricing of seasoned equity offerings.

48 Own development; some authors use the term seasoned equity offering as synonym for follow-on offerings as underlying shares of block transactions are also “seasoned”, but more common seems to be the use as drafted for only in connection with primary offerings

49 Some authors name acquisition issues, merger issues and vendor consideration offers as separate offers, but as they are always either rights issues, open offers or offers excluding pre-emptive rights with only a specific issue purpose characterising them, they will not be separately listed here.

50 Cf. Korteweg, Arthur (2003) p. 3

51 Terstege and Stark analysed the impact of exclusion of stock exchange based rights trading and found that there is in Germany a strong tendency to not arrange this trading due to save arrangement costs (cf. Terstege, Udo et al. (2006) pp. 31 f). In any case it is questionable if this “exclusion” will withstand a legal suite because there seem to be many facts that clearly show large wealth disadvantages especially for small shareholders. Therefore the arrange- ment is recommendable as long as there is now decision confirming the legality of “exclusion”.

52 Cf. Korteweg, Arthur (2003) p. 4

53 Cf. Armitage, Seth (2008) p. 3

54 Sometimes just called placings or placing with clawback

55 A special situation could be for example be a highly distressed balance sheet or acquisition financing

56 A rump placement with a clear discount to the subscription price is not allowed without preoffering the whole rump to this lower price again to the shareholder.

57 Of course there is also a placement fee that the banks charge equivalent to the finally placement volume; this underwriting implicates the risk for banks, that the share price falls below the nominal share value. This risk often is very low but never should be underestimated as recent rights issues have shown.

58 A “global note” is a certificate that securitises all shares on one certificate. This certificate is then physically stored at the stock exchange (i.e. at Clearstream in Luxemburg for Germany and others) while the shares are further traded only electronically

59 There are many studies analysing the phenomena of underpricing of SEOs. Important variables to determine the discount are i.e. the offering size, the market volatility, country specific laws and investor sentiment. For further information see i.e. Corwin, Shane A. (2003) pp. 2249 ff

60 Exemptions can for example be highly discounted rights issues as alternatives to dividend payments, see also section 2.2.4

61 Cf. Stoll, Jörg (2001) p. 1

62 Although the banks try to underwrite a price as low as possible, they later try to sell the shares as high as possible because their fees are usually linked total amount of proceeds.

63 Indirect effects could be given due to different taxations. See also section 2.3.1

64 Cf. sections 2.2.4 and 2.3.1

65 Cf. Bortolotti, Bernado et al. (2007) p. 4

66 Cf. Stoll, Jörg (2001) p. 2

67 Source: Own analysis of pricing methods with Dealogic

68 This clear differentiation is primarily based on differences’ between US-block trade- and Ontarian-bought deal law respectively. An interchangeable use of both terms is mainly due to very small differences’, between them. See also Bortolotti, Bernardo et al. (2007) p. 7

69 A private placement is also very similar to these deal types but is not a public offering in the reselling part and could be executed with a financial intermediate or directly to investors. Thereby underlying shares can be both, primary and secondary. See also Eckbo, B. Espen et al. (2004) p. 5.

70 Some definitions connect the term “block trade” only with the placement of secondary shares that again is can be processed together with various underwriting methods. Because there is not one exact definition available the letter definition is called “block transaction” in this thesis (cf. Figure 7)

71 “Market-out clauses” are special paragraphs in underwriting contracts that allow a cancelation of the agreed underwriting commitment in case of very special and unpredictable events. See also description of underwriting models later in this section.

72 Cf. Bortolotti, Bernardo et al. (2007) pp. 7 f.


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Fachhochschule für die Wirtschaft Hannover – Rights issues
Rights issues seasoned equity offerings share price discounts valuation effects conditional event study equity capital markets




Titel: Rights issue related discounts in France, Germany, Switzerland, and the United Kingdom