Costs of Bank Equity Offerings in Response to Strengthened Capital Regulation

Abstract

This paper studies bank new equity offerings in response to recently strengthened Basel capital regulation. Our empirical analyses investigate the determinants of issuing new equity and estimate its costs in sample selection model. The key finding is that weak capital base is one of the key driving forces of new issuance around the recently strengthened Basel regulation, though the banks were not capital deficient relative to the current regulatory minimum. In sharp contrast to the earlier studies, our empirical analyses provide supportive evidence for our penalty-aversion hypothesis. The Japanese bank managers recognize the inconveniences associated with the regulators' interventions and intend to shirk the costs of such restrictions on policies and actions when banks fail the regulatory requirements in the future.Consistently with this hypothesis, our empirical analyses also show that announcements of new equity issuance were associated with statistically significant negative abnormal returns. Bank equity offerings in response to strengthened regulation convey negative information on the risks of capital shortfall or associated costs of future interventions. Our results show that announcement returns associated with penalty-aversion issuing are greater than the returns associated with issuing for the repayment of governmental funds, the returns associated with timing-discretion issuing, or the returns associated with pure signaling issuing of the non-bank firm.Finally, we examine the determinants of adjusting capital ratio through asset contraction as well as recapitalization, using the estimated costs of recapitalization. Our results show that bank manager is more likely to choose the adjusting mean whose deviation from the industrial average is greater. However, the results imply that the issuing banks use the asset contraction complementally with recapitalization.