“What Drives Price Movement? Another Look at Market Reaction to Equity Offerings” by Zhangkai Huang
What Drives Price Movement? A perfect capital market predicts changes in stock price when equilibrium valuation of the stock changes. We look for factors other than this. We focus on a well-established event: the negative price reaction to the seasoned equity offerings. While this can be caused by asymmetric information, another plausible explanation might be a downward sloping demand curve for stocks. We argue that we can disentangle the two factors using a natural experiment in China's stock market, where companies' equity offering plans need to be approved by the regulator. We find strong negative price reactions to the announcement of such approval. Since all information on the overvaluation of the firm is released when the firm announces its equity offering plan, the negative reaction to the approval of the plan cannot be explained by changes in the valuation of the firm. Furthermore, we find different price reactions in China's segmented stock market when the firm only issues new shares in one of the two domestic markets (A- and B-share markets). The evidence suggests that a significant part of the negative price reaction of equity offerings is related to a supply shock to a downward sloping demand curve.