Do Firms Knowingly Sell Overvalued Equity?



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    • Case Western Reserve University. This article is based on the first essay of my Ph.D. dissertation at the University of Illinois. I am very grateful to my dissertation committee members, Narasimhan Jegadeesh, George Pennacchi, and especially Jay Ritter (chairman) for numerous valuable comments. Special thanks also go to René Stulz (the editor) and an anonymous referee for extensive comments that have significantly improved the article. I thank Tim Loughran, Ben Sopranzetti, David Yermack, and seminar participants at the University of Waterloo, University of Illinois, 1994 FMA Doctoral Student Seminar, Purdue University, University of Arizona, University of New Orleans, Case Western Reserve University, Michigan State University, and the 1996 Western Finance Association Meetings for useful comments; and Dennis Sheehan for providing data on announcement dates of seasoned equity offerings.


This article examines the relation between top executives' trading and the long-run stock returns of seasoned equity issuing firms. Primary issuers, who sell mostly newly-issued primary shares, significantly underperform their benchmarks, regardless of the top executives' prior trading pattern. However, top executives' trading is reliably associated with the stock returns of secondary issuers, who sell mostly secondary shares previously held by existing shareholders. On average, secondary issuers do not underperform their benchmarks. The results suggest that increased free cash flow problems after issue play an important role in explaining the underperformance of issuing firms.