Financial Intermediation and the Rights Offer Paradox

Abstract

In this study, we investigate the trading dynamics around rights issues. We employ signed and unsigned trading activity measures in order to provide evidence of costly financial intermediation. We, first, document short selling activity by underwriters and shareholders during rights issues leading to significant negative abnormal returns during the offer. Further, we provide evidence that rights tend to be sold below their fair value. Our results, therefore, suggest that the lack of use of rights offering, referred to as the rights offer paradox can be explained by indirect costs related to the nature of constraints confronting underwriters and shareholders but also to trading mistakes on the rights market.