equity,but leverage-decreasing events do not precede increases.Since the increase in financial leverage generally results in higher systematic equity risk,Shah concludes that the operating risk of the firm often falls after a leverage-increasing exchange offer.Born and McWilliams find no pattern of subsequent firm performance subsequent to equity-for-debt exchange offers that supports a signaling theory.Lie,Lie,and McConnell find evidence suggesting that debt-reducing exchange offers contain information that a firm is financially weaker than would have been apparent from other public information. The finding of decreasing systematic risk with some leverage-increasing transactions suggests that these transactions might convey information on changes in systematic risk. Reported empirical evidence,including cross-sectional studies,suggests that the theory of leverage signaling lags the empirical evidence.We are aware of no equilibrium models of leverage signaling involving private information about a firm's systematic risk or the misvaluation of that risk in the market.In general,the empirical evidence on debt issues is more supportive of the pecking order theory than it is of signaling with capital structure.Perhaps this is because investment is not held fixed in this type of leverage-increasing transaction,as is assumed in the signaling models discussed above. Operating performance and share price performance after repurchases and SEOs have also received a great deal of attention.Dann,Masulis,and Mayers,Bartov (1991),and Hertzel and Jain (1991)examine share repurchases,and all find evidence of earnings increases and of systematic (equity and asset)risk reductions after the repurchasing event.Lie and McConnell (1998)and Nohel and Tarhan(1998)confirm these results on earnings.However,Jagannathan and Stephens (2001)find no empirical evidence of improved operating performance after repurchases,and Grullon (2000)reports a significant decline in operating income and in 15
15 equity, but leverage-decreasing events do not precede increases. Since the increase in financial leverage generally results in higher systematic equity risk, Shah concludes that the operating risk of the firm often falls after a leverage-increasing exchange offer. Born and McWilliams find no pattern of subsequent firm performance subsequent to equity-for-debt exchange offers that supports a signaling theory. Lie, Lie, and McConnell find evidence suggesting that debt-reducing exchange offers contain information that a firm is financially weaker than would have been apparent from other public information. The finding of decreasing systematic risk with some leverage-increasing transactions suggests that these transactions might convey information on changes in systematic risk. Reported empirical evidence, including cross-sectional studies, suggests that the theory of leverage signaling lags the empirical evidence. We are aware of no equilibrium models of leverage signaling involving private information about a firmís systematic risk or the misvaluation of that risk in the market. In general, the empirical evidence on debt issues is more supportive of the pecking order theory than it is of signaling with capital structure. Perhaps this is because investment is not held fixed in this type of leverage-increasing transaction, as is assumed in the signaling models discussed above. Operating performance and share price performance after repurchases and SEOs have also received a great deal of attention. Dann, Masulis, and Mayers, Bartov (1991), and Hertzel and Jain (1991) examine share repurchases, and all find evidence of earnings increases and of systematic (equity and asset) risk reductions after the repurchasing event. Lie and McConnell (1998) and Nohel and Tarhan (1998) confirm these results on earnings. However, Jagannathan and Stephens (2001) find no empirical evidence of improved operating performance after repurchases, and Grullon (2000) reports a significant decline in operating income and in
analysts'earnings forecasts after repurchase announcements.Grullion's findings are consistent with Shah's results on leverage-increasing exchanges. Lakonishok and Vermaelen (1990),Ikenberry,Lakonishok,and Vermaelen (1995),and Chan,Ikenberry,and Lee (2001)find that the share performance of repurchasing firms is abnormally high for two to four years after the repurchase announcement.The underreaction findings led these authors to hypothesize that not only are shares undervalued when repurchases are undertaken,but also that it takes the market a long time to respond to the information provided in a repurchase announcement.'Dittmar(2002)also contends that share repurchase decisions are based on undervaluation. Hansen and Crutchley (1990),Ferris and Sant,McLaughlin,Safieddine,and Vasudevan (1996),and Loughran and Ritter(1997)document significant declines in operating performance subsequent to SEOs.However,Healy and Palepu (1990)report no decrease in firms'realized earnings.They also find,along with Lease,Masulis,and Page (1991)a significant increase in post-offering systematic risk.Brous (1992)and Jain (1992)report a downward revision in analysts'earnings forecasts in response to SEO announcements.Evidence on long-term stock performance reported by Loughran and Ritter (1995)and Speiss and Affleck-Graves (1995) documents abnormally poor equity returns for several years after an SEO,suggesting that the market under reacts to the SEO announcement.Speiss and Affleck-Graves (1995)and McLaughlin,Safieddine,and Vasudevan (1998)document similar results on long-term performance subsequent to bond issues.These findings sparked an on-going debate,with Fama (1998),Eckbo,Masulis,and Norli (2000),and Brav,Geczy,and Gompers (2000)suggesting 5 See Grullon and Ikenberry (2000)for a discussion of this underreaction evidence and the information content of repurchases. 16
16 analystsí earnings forecasts after repurchase announcements. Grullion's findings are consistent with Shahís results on leverage-increasing exchanges. Lakonishok and Vermaelen (1990), Ikenberry, Lakonishok, and Vermaelen (1995), and Chan, Ikenberry, and Lee (2001) find that the share performance of repurchasing firms is abnormally high for two to four years after the repurchase announcement. The underreaction findings led these authors to hypothesize that not only are shares undervalued when repurchases are undertaken, but also that it takes the market a long time to respond to the information provided in a repurchase announcement.5 Dittmar (2002) also contends that share repurchase decisions are based on undervaluation. Hansen and Crutchley (1990), Ferris and Sant, McLaughlin, Safieddine, and Vasudevan (1996), and Loughran and Ritter (1997) document significant declines in operating performance subsequent to SEOs. However, Healy and Palepu (1990) report no decrease in firmsí realized earnings. They also find, along with Lease, Masulis, and Page (1991) a significant increase in post-offering systematic risk. Brous (1992) and Jain (1992) report a downward revision in analystsí earnings forecasts in response to SEO announcements. Evidence on long-term stock performance reported by Loughran and Ritter (1995) and Speiss and Affleck-Graves (1995) documents abnormally poor equity returns for several years after an SEO, suggesting that the market under reacts to the SEO announcement. Speiss and Affleck-Graves (1995) and McLaughlin, Safieddine, and Vasudevan (1998) document similar results on long-term performance subsequent to bond issues. These findings sparked an on-going debate, with Fama (1998), Eckbo, Masulis, and Norli (2000), and Brav, Geczy, and Gompers (2000) suggesting 5 See Grullon and Ikenberry (2000) for a discussion of this underreaction evidence and the information content of repurchases