Firm’s Financial Health and its Impact on SEO Announcement Effects

Abstract: This paper examines the influence of investors’ beliefs about a firm’s financial health on the size of announcement effects of seasoned equity offerings. Altman’s Z-score for non-manufacturing firms is used as a quantitative measure for company health, and abnormal returns are calculated using event study methodology. The paper departs from a hypothesis that investors of healthy firms will react less negatively to the announcement of a secondary equity offering because they are confident in the firm’s stability and the firm’s ability to use the new capital profitably to increase shareholder wealth. The study finds that there is no significant difference between announcement effects for healthy firms and unhealthy firms and that the financial health of the firm, as measured by Altman’s Z-score, has no significant impact on abnormal returns after equity offering announcements. This suggests that investors’ knowledge of company health is insignificant compared to the negative signals sent to the market by the announcement. These signals most likely are the drivers of the negative announcement effects. In addition, the relationship between announcement effect and company financial health, although insignificant, is found to be negative, contrary to the original hypothesis. Ignoring its insignificance, this can be explained by risk averse investor behaviors. Using an unrestricted model with Altman’s Z-score variables, it is found that investors’ reactions to equity offerings are significantly affected by the illiquidity and the insolvency of the firm.