Equity Issues and Stock Price Dynamics

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American Finance Association

Equity Issues and Stock Price Dynamics Author(s): Deborah J. Lucas and Robert L. McDonald Source: The Journal of Finance, Vol. 45, No. 4 (Sep., 1990), pp. 1019-1043 Published by: Blackwell Publishing for the American Finance Association Stable URL: http://www.jstor.org/stable/2328713 . Accessed: 16/07/2011 10:21 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at . http://www.jstor.org/page/info/about/policies/terms.jsp. JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at . http://www.jstor.org/action/showPublisher?publisherCode=black. . Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org.

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Equity Issues and Stock Price Dynamics
DEBORAH J. LUCAS and ROBERT L. McDONALD* ABSTRACT infinite horizonmodelof the equity issue This paperpresents an information-theoretic, decision. The model predicts that (a) equity issues on average are preceded by an abnormalpositive returnon the stock, althoughfor some firms the issue is precededby a loss; (b) equity issues on averageare precededby an abnormalrise in the market;and (c) the stock pricedropsat the announcementof an issue. The modelprovidesa measure the of the welfarecost of asymmetricinformation; welfareloss may be small even if the price drop at issue announcementis large. THE ADVERSE SELECTION PROBLEM when firms issue new securities has been the focus of much recent work in corporatefinance. Seasoned equity issues have received particular attention, in part because there are striking stock price patterns aroundthe time of equity issues and considerablevariation over time in the numberof issues. In this paper we present a dynamic, infinite horizon model of the firm's equity issue decision under adverse selection. The model can simultaneously account for each of the following empirical observations about equity issues:'

* Stock prices of issuing firms on averageexhibit a large and extendedpositive abnormalreturnpriorto an equity issue. A sizable fractionof firms, however, have price declines in the period precedingan issue. * D. J. Lucas is from Finance Department, Kellogg School, Northwestern University. R. L. McDonaldis from Finance Department,Kellogg School, NorthwesternUniversity,and NBER. We RobertKorajczyk, thank Yuk-SheeChan,BruceGrundy,RaviJagannathan,NarayanaKocherlakota, Ren6 Stulz, and an anonymousrefereefor useful comments,as well as seminarparticipantsat Boston the College,Northwestern,the Universityof Chicago,the Universityof Illinois-Champaign, University of Southern California,and the NBER working group on Credit Market Imperfectionsand EconomicActivity. We are especially gratefulto Robert Korajczykfor his help with the data. This paperwas completedwhilethe secondauthorwas visiting the GraduateSchoolof Business,University of Chicago. 'Price behavioraround equity issues has been extensively documentedby Asquith and Mullins (1988), (1986), Masulis and Korwar(1986), Mikkelsonand...
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