Target leverage and the costs of issuing seasoned equity

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Abstract

In this paper, I examine the relation between the direct costs of issuing seasoned equity (SEO gross spreads) and the change in deviation of firms' leverage ratios from their estimated targets following SEOs. If underwriters have bargaining power vis-a-vis issuing firms in setting SEO fees and if the tradeoff theory of capital structure holds, then SEO fees should be negatively related to the post-SEO change in absolute deviation of firms' leverage ratios from targets. I find that this relation is indeed negative and economically and statistically significant, especially in cases in which underwriters have relatively high bargaining power, suggesting that one of the important determinants of SEO fees is the change in firms' absolute deviations from their target leverage as a result of issuing seasoned equity, and that underwriters are able to capture part of the value created by firms moving towards their leverage targets.

Original languageEnglish
Pages (from-to)39-52
Number of pages14
JournalFinance Research Letters
Volume7
Issue number1
DOIs
Publication statusPublished - Mar 2010
Externally publishedYes

Keywords

  • Issue costs
  • Seasoned equity offerings
  • Target leverage

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