ARE SEASONED EQUITY OFFERINGS DRIVEN BY OVERVALUATION? EVIDENCE FROM THE REAL ESTATE INDUSTRY

Abstract

Many studies on Seasoned Equity Offerings (SEOs) in industrial firms show that SEO firms underperform their non-issuing counterparts in the long term after issuance. However, there is still inconclusive explanation on whether the long term underperformance is driven by overvaluation or by agency problem of free cash flow. This study focuses on SEOs in the context of the real estate industry, particularly Real Estate Investment Trusts (REITs), which are less subject to agency problem of free cash flow due to the mandatory distribution of 90% of earnings to shareholders. By examining SEOs in REITs and homebuilders in the US market from May 2002 to December 2009, this study provides new evidence that SEOs in the real estate industry are likely driven by overvaluation. I find that the short term return, long term return and long term operating performance of the SEO firms underperform the industry benchmark following the SEOs. However, there is significant heterogeneity across the SEOs and I find evidence for the overvaluation hypothesis only in the subset of firms with low past net investment, low issue day return and high increase in operating performance prior to SEOs. In addition, unlike SEOs in other industrial firms, I find no evidence of overinvestment in REITs following SEOs. Overall, this study shows that overvaluation prior to issuance plays an important role in determining the SEO decision and its long term underperformance in REITs.