Question

39.Why does the stock price tend to drop when firms announce a seasoned equity offering?

Select one:a. Because it signals that the issuing firm could be in financial trouble.b. Because the new shares will dilute the earnings of existing shareholders and so the company stock cannot be worth the same amount anymore.c. The price only drops when firms state that they intend to use the new funds to undertake projects that have a negative net present value.d. Because investors know that the new issue is underpriced and so the existing shares must adjust to account for this

Answer 1

When a firm announces a seasoned equity offering or secondary offering, it increases the number of shares outstanding in the market. Companies can raise money via secondary offering for many reasons such as to finance its debt, make acquisitions etc. As the number of shares increases, it results in lower-earning per share due to the dilution of per-share earning and hence the price drops.

Hence the answer is b) Because the new shares will dilute the earnings of existing shareholders and so the company stock cannot be worth the same amount anymore.