Equity Issuance and Adverse Selection: A Direct Test Using Conditional Stock Offers

Authors

  • JOEL F. HOUSTON,

  • MICHAEL D. RYNGAERT

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    • Both Houston and Ryngaert are from the Graduate School of Business, University of Florida. We thank Chris James, David T. Brown, Mark Flannery, Charles Hadlock, and Subu Venkataraman for their helpful comments. Alison Miller and John Race provided valuable research assistance.


ABSTRACT

We conduct a unique test of adverse selection in the equity issuance process. While common stock is the dominant means of payment in bank mergers, stock acquisition agreements provide target shareholders with varying degrees of protection against adverse price movements in the bidder's stock between the time of the merger agreement and the time of merger completion. We show that it is the degree of protection against adverse price changes and not the percent of stock offered in a bank merger that explains bidder merger announcement abnormal returns. This result is difficult to explain outside of an adverse selection framework.

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