To explain adverse investor reactions to corporate announcements of seasoned equity offerings (SEOs), the authors use a difference-in-differences statistical test to focus on situations that are unfavorable for good governance. Such situations involve business combination statutes (BCS) that reduce the likelihood of corporate takeovers. The authors conclude that in such contexts, SEOs implemented to pursue acquisitions can be discouraging to investors because they view such SEOs as potentially unproductive. Market reaction is more negative for issuers with a weak history of executing value-enhancing mergers and with weaker managerial wealth sensitivity to shareholder value as evidenced in compensation policies. These governance effects are surprisingly large, accounting for most of the previously identified unfavorable market appraisal of primary SEOs.

The authors make their research relevant for practitioners by connecting such timely topics as the validity of “build versus buy” for business development, the relationship between governance and managerial motivation, and the efficacy of shareholder activism in light of regulatory change. They sidestep the debate on expectations, as summarized by the single metric of market to book value and its signaling effect for high-growth opportunities. Instead, they focus on constraints arising from agency issues, with the evolving governance framework as the medium for the alignment of interests between managers and owners, and address both sides of the related issues.

For investors, the authors model fairly precise cost estimates of both antitakeover rules and incumbent managers who are ineffective at acquisitions. These two investment hurdles result in an approximate sacrifice of total returns of 2% and 1.2%, respectively. For corporate managers seeking external financing, the authors estimate an increased cost of 7.4%–9.2% of the total proceeds raised when their firms are perceived as being aligned with internal self-interest. These detrimental financing costs are exacerbated when secondary share offerings from management are accompanied by a primary SEO event. And for both investors and insiders, the related drawbacks are experienced fairly quickly, with the bulk of the effect concentrated in the year following BCS enactment.

The authors rely on multiple data sources—including the Thomson Reuters SDC, ExecuComp, Compustat, and CRSP databases—to track primary share offerings by US firms in the period of 1982–2006, concentrating on a given year’s first SEO when multiple offerings are made annually. Solely secondary offerings are excluded. Regression models are applied within the shorter period of 1982–1990, when there were active efforts in 28 states to enact BCS rules limiting takeovers, resulting in a final test sample of 1,066 SEOs.

Their statistical method is a difference-in-differences approach that portrays BCS as an external shock that weakens corporate governance. Their approach has two stages: The first is studying the BCS enactment effect around the period of the announcement (filing date), and the second is estimating the interactive effect of capital expenditure increases (defined as acquisitions) and the BCS in the given year of SEOs as an ex post proxy for weak governance. Benchmarks for the acquisition history of corporate issuers are calculated to determine the related effectiveness of management. Allowance is made for the state of incorporation (with special attention to Delaware), but no special geographic effect is identified.

Complementing the primary analysis of the SEO–BCS interaction, the deltas of the firms’ top managers (i.e., the sensitivity of the value of their firm stockholdings to changes in the firm’s stock price) are calculated to determine the effect of wealth sensitivity on returns. The models also undergo robustness tests, which confirm there are no significant omitted variables.

With shareholder activism becoming an increasingly prominent investment strategy and with investors who follow more traditional approaches experiencing increased attention on their proxy voting, the impact that governance choices have on returns is not merely hypothetical. The authors provide evidence for the proposition that “voting with one’s feet” can be hazardous to one’s wealth and that legislated adjustments to improve the market for corporate control are accompanied by real, if subtle, costs. Absent such interventions and given the stewardship of empathetic management, existing investors are not troubled by the prospect of dilution from an expanded equity base.