Strategic Financial Management Part II: Seasoned Equity Offerings, Corporate Payout Policy, and the Case of Regulated Utilities

As discussed in the predecessor to this article that came out roughly two years ago, each of today's three dominant academic theories of capital structure has trouble explaining the financing behavior of public companies making seasoned equity offerings (SEOs) of their own stock. In conflict with the tradeoff theory, the authors' analysis of some 7,000 SEOs by U.S. industrial companies during the period 1970-2017 finds that the vast majority, or roughly 80%, of them had the effect of moving the companies away from, rather than toward, their target leverage ratios. Inconsistent with the pecking order theory, SEO issuers have tended to be financially healthy companies with considerable unused debt capacity. And at odds with the market-timing theory, SEOs appear to be driven more by the capital requirements associated with the large investment projects that tend to follow them than by favorable market conditions and overvalued stock prices.

Nevertheless, consistent with the tradeoff theory, the authors also find that SEO issuers tend to follow their stock offerings with one or more debt offerings that have the effect of raising their leverage back toward their targets. And whereas all of the three theories are “single-period models” suggesting some degree of shortsightedness and “opportunism” by financial managers, the authors' findings present a picture of long-run-value-maximizing strategic management of corporate capital structures—one that takes account of the company's current leverage in relation to its longer-run target, investment opportunities, and long-term capital requirements, and the costs and benefits associated with alternative sequences of financing transactions.

Building on their earlier article, the authors extend their analysis to examine the payout and well as leverage and investment decisions of SEO issuers—and expand their sample of some 7,000 industrial issuers to include another 1,500 SEOs by regulated utilities. In the wake of the SEOs, both dividends and repurchases tend to increase; but the payout rates for utilities were almost eight times higher than for industrials, and overwhelmingly take the form of dividends rather than buybacks.

In the final sections of the article, the authors first attempt to explain the negative stock price reactions to the announcements of SEOs, and then speculate about the causes of the even more negative, and puzzling, long-run stock returns to industrial, but not utility, SEO issuers.