Question

The stock market on average reacts negatively to the announcement of a new round of equity issuance (SEO) but reacts positively to the announcement of new debt issuance. How can you explain this pattern assuming there is information asymmetry between firms’ insiders and outsiders? Keep your answer precise and to the point.

Answer 1

The new round of equity issuance would result into dilution of the original shareholders equity and it will also increase the shareholders base.

Equity issuance would also be disadvantages in the the sense that the price to earning ratio of the company will go down and the number of shares will go up and it will also be a reflection that management is not bullish on the company as they are selling their stakes.

Issuance of debt is positively factored into, because that will insure that company is able to generate enough profits to fund its debt repayment and company also do not want to dilute its shareholders base. It will also lead to a higher tax deduction in form of interest payments tax shield.