Question

In a recent meta study authors founds that the price of the company stock rise when the shareholders agreed with the board to issue more common stock shares.

1.             Why do you think this happened?
2.             What in the decision process about the stock issuance could have provoke the price of the stock to go down when announcing the issuance of the new shares.

Answer 1

a) This will happen when the company have the high debt compared with equity. Assume that the debt equity ratio is

4 : 1 and company has total equity + debt = 1 million. That means 0.8 million debt and 0.2 million equity.

Assume that the company raised additional 0.8 million equity to pay off debt and save money on interest payment.

Adding that interest rate for the debt was 15 % and company was paying 120K as interest payment. Company can save this money if they raise additional capital. This will leads to the favourable debt equity ratio, increase the liquidity also reduce the credit risk. This is the case when management take decision and stock price reacts favourably.

b) Assume that company has a high dividend payout as well as high profit and management take decision to buy (acquire) loss making company before that they want to raise additional capital. Additional capital in the means of issueing this profit making company's shares to loss making company's share (inorder to acquire).

This is one of the case the stock price reacts badly when management announce stock issuance.