NO. 03-32

Rezaul Kabir, Tilburg University, the Netherlands

Kiel Institute of World Economics University of Oxford University of Rome, La Sepienza Institute for New Technologies, United Nations University Warwick Business School, University of Warwick

Project financed by the European Commission, DG Research Improving the Human Potential and the Socio-Economic Knowledge Base Programme

CORPORATE FINANCING IN THE NETHERLANDS: SOME EMPIRICAL EVIDENCE

Rezaul Kabir* ? ovember 2003

Abstract The purpose of this paper is to examine the financing behaviour of Dutch corporations and its impact on firm performance. First, I present some stylised facts of corporate financing in the Netherlands. I show how the Dutch financial system differs from other major financial systems. Second, I analyse the valuation effect of different types of security offerings made by Dutch quoted firms. An evaluation of the determinants of the valuation effect is also made. Third, I explore the long-term impact of equity offerings by focusing on fundamental performance measures. JEL classification: G21, G32, G31, G35 Keywords: financial systems, corporate governance, capital structure, security offering.

ISSN 1682-3739 Copyright @ 2003 EIFC Consortium [Contract No HPSE-CT-1999-00039] Published by the United Nations University, Institute for New Technologies, Keizer Karelplein 19, 6211 TC Maastricht, The Netherlands E-mail: [email protected] URL: http://www.intech.unu.edu ___________________ *Department of Finance and Center for Economic Research, Tilburg University, Room B931 P.O. Box 90153, NL-5000 LE Tilburg, The Netherlands. E-mail: [email protected]

TABLE OF CONTENTS

INTRODUCTION

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DUTCH FINANCIAL SYSTEM

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PRIVATE AND PUBLIC CAPITAL MARKET ROLE OF BANKS

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CORPORATE GOVERNANCE

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FINANCING BY DUTCH FIRMS

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WEALTH EFFECT OF SECURITY ISSUES

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EQUITY OFFERINGS OTHER SECURITY OFFERINGS

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LONG-TERM PERFORMANCE

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CONCLUSIONS

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REFERENCES

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TABLES AND FIGURES

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INTRODUCTION Raising capital through security offerings is an important event in the financing pattern of listed corporations. The use of different types of securities and their effect on firm value varies from country to country due to differences in financial systems and institutional factors. According to Brealy and Myers (2002), companies face two basic financing decisions: How much profit should be ploughed back into the business rather than paid out as dividends? What proportion of the deficit should be financed by borrowing rather than by an issue of equity? These are the central corporate financing decisions for each and every firm. Companies can raise capital internally by retaining earnings and externally from the capital market. The two principal external sources of raising capital are equity and debt. These come from either private sources like bank loans and private placements, or public sources like issuing new securities in domestic and foreign capital markets. Along with an analysis of bank loans and, to a limited extent, private placements, the investigation of security offerings to the public has been a fascinating area of academic research in corporate finance. By deciding to issue one or another type of security, firms are constantly changing its capital structure. It is widely known that under strict assumptions of perfect capital market capital structure of firms does not affect value of the firms. As long as the total cash flow generated by the assets of the firm remains unchanged, financing decisions do not change the overall firm value. Studies have relaxed these assumptions one by one and shown their relevance in real (and imperfect) world affecting firm value. The real world shows interplay of different factors that determines the ultimate value consequence of capital structure decisions. Capital structure decisions of firms are believed to be used as an attempt to reduce taxes and bankruptcy costs, and/or as signalling, bonding or control devices. Indirect test on the support of these theoretical postulates is made on the basis of survey research (Graham and Harvey, 2001). On the other hand, direct empirical test of validity of these factors is performed by looking at the change in market value of common stocks and examining the determinants of the value change. This paper discusses some of these empirical tests. Several studies examine the effect on shareholder wealth when changes in capital structure take place due to issuance of equities and debts. Ross, Westerfield and Jaffe (2002) note the following: “It seems reasonable to believe that new long-term financing is arranged by firms after positive net present value projects are put together. As a consequence, when the announcement of external financing is made, the firm’s market value should go up. (p. 543)” The empirical evidence, on the other hand, demonstrates a decline in share price at the

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announcement of common stock and convertible bond offerings, and an insignificant stock price movement at the announcement of straight debts. The analysis of the reasons of this seemingly anomalous empirical result has been a constant source of scientific research. The purpose of this paper is to analyse the valuation effect of financing decisions of Dutch firms by specifically examining different types of security offerings. I proceed as follows. First, I review the main features of the Dutch financial system and show how it differs from other major financial systems. I also present some stylised facts of corporate financing in the Netherlands. I provide information on internal and external financing as well as the capital structure of Dutch firms. Many scholars point out that the observed differences in financial systems can explain the differences in firms’ corporate financing behaviour. Second, I analyse the stock market valuation effect of different types of security offerings made by Dutch firms. I relate these effects with several theoretical explanations put forward to explain firm’s capital structure choice. An evaluation of the determinants of the valuation effect is also made. Third, I explore the long-term impact of stock offerings by focusing on fundamental performance measures. Such an analysis allows us to evaluate if real market firm performance is consistent with the stock market-based performance

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DUTCH FINANCIAL SYSTEM In this section, I focus on the salient features of the Dutch financial system and illustrate how it is different from some other major financial systems. In general, the Dutch system is a mixture of the Anglo-American (capital market-based and dispersed ownership-oriented) and the German (bank-based and concentrated ownership-oriented) systems. Capital market control, competition and shareholder wealth maximization characterize the Anglo-American system. On the other hand, the German system is characterized by bank control and stakeholder wealth maximization.

Private and public capital market Public corporations in the Netherlands are quite small in number, but very large in size. There are about 2,000 public limited companies, of which about 250 are listed on the stock market. On the other hand, there are more than 150,000 private limited companies. The role of public capital market is also limited as far as the issue of new securities is concerned. Relatively few Dutch firms issue shares and bonds publicly. During 1984-1999, a total of 146 Dutch firms have listed their shares on the stock exchange. Roosenboom (2002) finds that companies of a wide range of sizes and numerous industry groups go public. The median initial public offering comprises 22 million Euro worth of shares with a minimum of three millions Euro and maximum of 1,477 millions of Euro. The average Dutch company does not use its IPO to raise large amount of new equity capital. Instead, the larger part of the proceeds goes to pre-IPO owners that cash out by selling (part) of their existing shares. This phenomenon contrasts sharply with that of the United States. The average IPO underpricing, measured as the offer-toclose return on the first day of trading, is 9.5%. This compares to an average underpricing of 11% reported for Germany, 12% for the UK, and 14% reported for France and the US. The major proportion of Dutch firms is privately financed. Bank loans are thought to play the most significant role in the external finance of Dutch corporations. Firms rely more on bank loans because of difficulties in accessing the public securities market at attractive terms. De Haan and Hinloopen (1999) perform a long time-series analysis of the amount of funds obtained externally (private loans and issuing securities) by Dutch non-financial companies. They find that private loans always dominate external sources of funds. The respective proportions have changed somewhat during the 1990s due to the booming security market of these years.

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Table 1 provides information on the listed companies in the Netherlands and compares with those of some other countries. We observe that there are 392 domestic and foreign companies listed in Amsterdam with a total market capitalization of $640 millions. This is much smaller than Germany and Paris, not to speak of London, New York and Tokyo. The total stock market capitalization of Dutch firms is equal to almost half of the country’s gross domestic product. This is also less compared to the German stock market capitalization of about 60% and nearly 200% for the United States. A unique feature of the Dutch capital market is the dominance by a handful of very large companies. Fifteen companies including Royal Dutch, Unilever, Philips, Elsevier, Ahold, Akzo-Nobel, ING and ABN-AMRO represent about 70% of total market capitalization. The major multinational company Royal Dutch alone accounts for almost 20%.

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ROLE OF BANKS The banking system is extremely concentrated in the Netherlands. The share of three main commercial banks (ABN-AMRO, ING and Rabobank) in total bank assets is more than twothird. This concentration is very high, compared to, say Germany, where the share of the main three banks is less than one-quarter. Banks have been the major source of funds for Dutch firms. The banking literature suggests that bank loans have both benefits and costs for firms. Empirical studies on Dutch bank loans are not available as it is difficult to find information on long-term loans provided to firms. Chirinko et al. (1998) analyse short-term bank loans and report that the median short-term bank loans as a percentage of total assets is 6%. Dutch banks also engage in both commercial and investment banking businesses. Although there is no restriction of banks owning shares of companies, their average shareholdings are not significant. Bank’s representatives usually take sit on the supervisory boards of many firms. As pointed out by Chirinko et al. (1998), this is not the result of the banks being a shareholder, but it merely reflects informal linkages through networks. Such a networking provides Dutch financial institutions with the opportunity to gather information about a firm and is also a potential means to exercise indirect control on the firm. There is also much similarity with Germany where bank equity holdings are relatively low, but the power is enormous especially through proxy voting and representation on supervisory boards (Gorton and Schmid, 2000).

Corporate governance Two main aspects of corporate governance that receive most attention are the ownership structure and the board structure of firms. Like many other industrialized countries, ownership and control are, in fact, not separated in the Netherlands. One or two owners with significant blocks of shares may effectively control the affairs of a whole company. Therefore, studies of ownership concentration have gained prominence. Among the Continental European countries, Dutch companies have a relatively low concentration of ownership. The median size of the largest ownership block is 18%; for the top three blockholders together, the figure is 34%; for all large blockholders, it is 48%. A relatively large number of firms have ownership stakes in the 25 – 50% and 50 – 75% ranges. The average ownership stakes of banks, insurance companies and other financial institutions are 7%, 10% and 15%, respectively. More than 50% of Dutch firms have a bank as a blockholder. In onethird of firms, an insurance company is another blockholder. Individuals and corporations have

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average stakes of 10% and 2.5%, respectively. This scenario is different from Belgium and Germany where cross-holdings by corporations play an important role. Renneboog (2000) finds that the largest direct shareholder controls 43% in the average Belgian listed company. Holding companies, industrial corporations own 33% and 15% of the voting rights, respectively. In Germany, individual and families, industrial companies and financial institutions are the dominant shareholders. An important feature of the Netherlands is that voting rights are different from ownership rights. This means that ordinary shareholders do not have the rights which are considered as normal in many other countries. When voting rights are taken into consideration, the Netherlands can be considered as one with a relatively high concentration. The average size of the largest voting stake is much higher due to the fact that blocks of shares are controlled by administrative office that holds the original common shares and issues depository certificates instead. The use of administrative office is one of the several anti-takeover measures adopted by Dutch listed companies. Certificate holders, in addition to dividends, retain the right to attend and speak at shareholders’ meetings, to challenge the legitimacy of company decisions, and to call for extra meetings just like any shareholder. But they have no vote; the voting rights attached to their shares can only be exercised by the administrative office. These two classes of shares are not traded simultaneously on the Exchange. It is also important to note that other categories of owners, such as banks, insurance companies, and pension funds have, on average, very few voting rights. A detailed analysis of these and other anti-takeover measures in the Netherlands is given in Kabir, Cantrijn and Jeunink (1997). The board structure of many European companies reflects the idea that the firm should act in the interest of all stakeholders, not just the owners. In this spirit, Dutch firms have two-tire boards of directors. Many firms are legally obliged to appoint a supervisory board whose members are appointed by cooptation (i.e. the incumbents elect new members) with no direct shareholder input. The supervisory board in turn names a management board. The management board controls day-to-day functions. It also influences the composition of the supervisory board. Therefore, one can raise question on the degree of independence of the Dutch supervisory board. Many individuals are usually members of several supervisory boards. The median size of the management board is two while that of the supervisory board is five. The largest management board has 14 members and the largest supervisory board has 11 members. There are 20% of Dutch firms in which blockholders or their relatives are members of the supervisory or the management board. The average ownership stakes of the management board members, the supervisory board members, and their relatives are 5%, 2% and 1%, respectively. In a few firms members of the supervisory board hold ownership stakes but those of the management board do not. German companies have also a supervisory board. The main

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difference with Germany is that one-half of the supervisory board’s members is elected by employees, including management and staff as well as trade unions. The other half of the supervisory board represents shareholders, often including bank executives.

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FINANCING BY DUTCH FIRMS Empirical evidence suggests that Dutch firms, like firms in many other industrialized countries, prefer internal funds to external funds. De Haan and Hinloopen (1999) analyse financing techniques used by Dutch companies. They collect time-series data of Dutch non-financial companies for the years 1984-1997. From a sample consisting of 1915 annual observations, they find that 43% of firms do not require any form of financing. In 1085 (57%) cases, companies do use one or another type of financing method. The distribution of financing techniques is shown in Figure 1. We can see that pure internal financing is used in 45% cases whereas external financing is used in 40% cases. The rest belong to a combination of internal and external financing. If external financing is obtained, we observe that the most common source is financing by means of private debt (51%). The remaining proportion is divided among issuing equity (20%), bonds (15%) and hybrid financing (18%). The overwhelming dominance of internal finance is also observed in the UK and the US. The empirical analysis of de Haan and Hinloopen (1999) indicates that the choice between internal and external financing depend on the availability of internal cash flow and liquid assets. Firms with sufficient internal funds are less likely to acquire external finance. When firm require external funds, it is found that profitable firms and smaller firms are more likely to use private debt than public security offerings. Smaller firms are more dependent on banks for external funds while larger firms have easier access to capital market. Like most continental European markets, the corporate bond market is relatively underdeveloped in the Netherlands. De Haan and Hinloopen (1999) mention several institutional factors to explain this phenomenon. The supply side of the Dutch capital market is dominated by institutional investors (pension funds, life insurance companies), which until recently invest mostly in relatively risk-free long-term government bonds and loan. They were legally restricted to invest in risky assets. Since the lifting of legal barriers, pension funds have increased their investment in risk-bearing assets like shares. The corporate bond market, however, does not have the necessary infrastructure to take advantage of this new development. There is an increasing need for market analysts and rating agencies to assess the quality of companies. It is also important to get an idea on the extent of debt and equity financing used by Dutch corporations. Past research has used a number of different definitions of leverage. These vary depending on long-term, short-term or hybrid nature of debt. Empirical literature uses these different measures because different theories of capital structure have different implications for

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different types of debt. The capital structure of Dutch firms is analysed by de Jong (1999). He uses several measures of leverage. Long-term debt ratio is calculated as the book value of longterm debt divided by the book value of total assets. Alternative definitions of leverage are longterm debt over market value of total assets, total debt over book value of total assets, and total debt over the market value of total assets. Short-term debt is defined as short-term debt over the book value of total assets. The empirical findings are presented in Table 2. We find that the median long-term debt ratio in the Netherlands is 14%. Measuring long-term debt in terms of market value indicates a slightly lower figure. It is difficult to compare this and other measures of leverage internationally. As pointed out by Rajan and Zingales (1995), international comparisons of this sort are extremely difficult due to accounting differences among countries. For example, the treatment of reserves and pensions liabilities has different consequence on the actual amount of debt and equity used by firms. Rajan and Zingales (1995) adjust for these items. The long-term debt ratio in the Netherlands is comparable to that of Germany (0.10), France (0.16), Italy (0.12) and the United Kingdom (0.12), but low in comparison with the United States (0.23) and Canada (0.28). As for the Dutch IPO firms, Roosenboom (2002) reports that the median long-term debt in the financial year before the IPO is only 6%. We also see that Dutch firms tend to rely more on short-term finance. The average short-term debt ratio is 35%. Short-term debt accounts for the bulk of total debt financing. It allows banks to frequently monitor firms and to exercise potential monopoly power in case of loan renegotiations. UK firms appear to have a similar degree of reliance on short-term firms. But, Dutch firms rely more on short-term finance than German firms. It is believed that trade credits play an important part of short-term debt. While Germany and the Netherlands are examples of bank-oriented financial systems and listed firms in these two countries appear to have similar aggregate leverage structures, there are some important differences. Specifically, the largest firms in Germany tend to have lower leverage ratios compared to the Netherlands, and second, the financing of firms in Germany appears to be more long-term than the Netherlands.

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WEALTH EFFECT OF SECURITY ISSUES Published empirical studies on capital structure choice in general indicate that the effect of taxes and bankruptcy costs appear to play a minor role in explaining the financing behaviour of corporations. Most studies rather conclude that information and agency considerations are more dominant factors. According to Grinblatt and Titman (2002), a firm’s choice of debt or equity conveys information for two reasons. First, managers will avoid increasing a firm’s leverage if they have information indicating that the firm could have future financial difficulties. Hence, a debt issue can be viewed as a signal that managers are confident about the firm’s ability to repay the debt. Second, managers are reluctant to issue what they believe underpriced share. Hence, an equity issue might be viewed as a signal that the firm’s shares are not underpriced, and therefore may be overpriced. A number of studies from several countries examine stock price reaction to the announcement of new security issues. In this section, I review the results obtained from the Netherlands and compare them with prior studies.

Equity offerings Listed corporations typically raise additional external equity capital either from existing shareholders or from new investors. The first method is commonly known as rights issue and is widely used in diverse European and international capital markets. The second flotation method, commonly known as general cash or public offers is the usual practice in the United States. In line with other European countries, rights issue is the usual practice in the Netherlands. Corporate charters provide existing shareholders the pre-emptive right to purchase new issues of common equity. Another special feature is that Dutch firms always adopt standby rights offer method. Thus, investment banks or other financial institutions guarantee the execution of any unexercised rights. During the period 1983 – 1998, there were about 90 seasoned equity offerings made by Dutch listed firms. Of these issues, almost 20% were general cash offers while the rest were rights issues. The few non-rights equity issues were made jointly on international stock markets and/or related to organizational restructuring. Firms issuing rights offerings are on average much smaller than firms issuing general equity. The proceeds obtained from equity issues are used in repaying debt, restructuring operations, new investments, financing takeovers, or simply to improve solvency.

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Kabir and Roosenboom (2003) perform a detailed analysis of a sample of 58 rights issues in the Netherlands. Some descriptive information on the issue-size and the issue-price is presented in Table 3. By scaling the monetary amount of equity issue with the market value of common equity on the day before announcement, it is found that the average equity issue represents 21% (median = 16%) of firm’s outstanding common equity. This is roughly similar to issues in the U.S. and U.K. Analysing the offer price of equity issues we observe that it is, on average, set below the market price prevailing during the days before the announcement. The average issueprice (subscription price discount) is 88% (13%). This is slightly less than the average offerprice discount observed in case of insured rights offerings in the U.S. (20%) and in the U.K. (17%). The average subscription price discount is remarkably higher in Norway (about 50%) and Greece (38%). Empirical result on shareholder wealth effect of announcements of equity offerings is presented in Table 4. Excess stock returns are estimated after adjusting for each stock’s systematic risk estimated from the Market Model. The results show that the stock price announcement effect is significantly negative. On the day of the announcement of rights issue (day 0), the average excess decline is about two percent. An additional half a percent decline takes place on the day after the announcement. In two days time, shareholders of rights issuing firms suffer an average abnormal wealth reduction of about 2.8%. The result is also consistent with that found earlier by Levis (1995) and Slovin et al. (2000) for the UK; Bohren et al. (1997) for Norway; and Gajewski and Ginglinger (2002) for France. In contrast to these findings, Kang and Stulz (1996) and Tsangarakis (1996) observe a positive valuation effect in Japan and Greece, respectively. It is possible that the positive stock price effect is caused by distinct institutional features of these stock markets like the absence of an active market for rights and highly concentrated / affiliated ownership structure of firms. The results presented in Table 4 also show that Dutch companies issue equity after an increase in stock price. Similar result is found by de Jong and Veld (2001). Equity issue announcements usually take place together with other kinds of news announcements. A robustness check of confounding events does not change the direction of average price reaction. It is also observed that equity issuing firms with new investment plans experience a statistically significant decline in their stock price. However, the magnitude of the stock price decline is smaller than that obtained for the total sample. Which firm-specific factors can explain this decline in stock return of equity issuing firms? To investigate this, a cross-sectional regression analysis is performed and the results are shown in Table 5. The announcement period cumulative excess stock return is used as the dependent variable. The explanatory variables are used to proxy three different hypotheses: the information asymmetry (Myers and Majluf, 1984), the free cash flows (Jensen, 1986) and the window of

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opportunity hypotheses (Bayless and Chaplinsky, 1996; Choe et al. 1993). We find that (in model 1) that the announcement period excess stock return is inversely related to the relative size of the rights issue. In this univariate analysis, the magnitude of the issue-size coefficient is –0.11 and it is statistically significant. The finding indicates that as the relative size of the rights issue increases, a larger decline in the stock price takes place. The result supports the prediction of the information asymmetry hypothesis that larger equity issues signal more negative information thereby depressing stock prices more. A significant positive relationship exists between the announcement period excess stock return and the relative offer price. The univariate regression coefficient of the variable is 0.31 (model 2) and is statistically significant. The explanatory power of the issue-price variable is larger than that of the issue-size variable. The result is again consistent with the information asymmetry hypothesis which posits that higher quality firms use higher subscription price, or smaller discounts, as a signal of quality, and therefore, experience a less negative price decline. Prior studies (e.g. Slovin et al., 2000) also find significant relationship between offer price discount and announcement period stock returns. When both the issue-size and the issue-price variables are used in a bivariate regression framework (model 3), we observe similar negative and positive coefficients, but the coefficient of issue-size variable becomes statistically insignificant. Additional investigation reveals the presence of statistically significant correlation between these two explanatory variables. The overinvestment of free cash flows hypothesis predicts that stock return will be positively related with issuing firms’ market to book ratio of total assets. The results of models 4 and 5 in Table 5 show that although the coefficient of the market to book ratio is positive, it is statistically insignificant. To determine whether corporate managers utilize the opportunity of favourable economic conditions to issue new equity, the relationship between announcement period stock return and the annual growth rate of gross domestic product is investigated. As can be seen in model 5, the GDP growth rate is insignificantly related to stock returns. The above findings, therefore, fail to support the overinvestment hypothesis as well as the window of opportunity hypothesis.

Other security offerings Besides equity, companies can choose to issue pure debt, or hybrid securities that have both equity and debt components, like convertibles and warrants. By issuing bonds, a firm receives additional external funds but increases its leverage and external disciplining by bondholders. The capital market, therefore, interprets bond issues as a mixed signal. The fact that a firm needs new financing indicates a shortage of internal funds which investors consider as bad

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news. On the other hand, the higher leverage is a signal that the company is confident about its ability to meet higher interest obligations and thereby to generate higher cash flows. De Jong and Veld (2001) analyse 98 issues of straight debt during the period 1977-1996. They also make a comparative analysis with equity issuing firms. The results indicate that debtissuing firms are more profitable than equity issuing firms, and companies issue debt after a decline in stock price. The wealth effect of debt announcements, as shown in Table 6, is positive (0.51%) but statistically insignificant. The finding generally supports that of prior studies from the US. De Jong and Veld (2001) also examine the determinants of abnormal stock returns associated with debt issues. They find that, consistent with theoretical prediction, announcement period abnormal return is positively related with firms’ growth opportunities. But, in contrast to the expectation, they also find that firms with a relatively large amount of short-term funds like cash and other liquid assets, and using the proceeds to repay short-term debt experience higher abnormal returns. The size of debt issue has no relationship with abnormal stock returns. An analysis of financing by convertibles and warrants is made by de Roon and Veld (1998). A convertible bond gives its owner the right to exchange the bond for other securities, mostly stocks. The owner of a convertible bond owns a bond and a call option on the firm’s stock. On the other hand, a company issues warrants that give its owner the right to buy other securities, mostly new shares. The main difference is that warrants are separately traded securities, while in case of convertibles, the bond and the conversion right are always traded together. During 1976-1996, there were 62 convertible bonds issues and 22 warrant bonds issues in the Netherlands. Out of these issues, they collect detailed information on 47 convertibles and 19 warrants. The mean market value of new equity as a fraction of the market value of the outstanding equity is 22% for convertible bonds and 15% for warrants. The issues are, on average, large in relation to the outstanding equity. The effect of financing by issuing convertible bonds and warrants is empirically examined by performing an event study. The results presented in Table 6 show that the average abnormal stock return from day –1 to day +1 is 0.53% for convertible bonds and 1.35% for warrants. The former is statistically insignificant while the latter is significant. These results are in line with the results for Japan, but they are inconsistent with the results obtained from the US. An issue of convertible in the US is usually associated with significant negative impact on shareholder wealth. Looking at the abnormal stock returns prior to issues, de Roon and Veld (1998) observe that Dutch firms issue both securities after a period of positive stock price gains. They also find that Dutch companies generally announce the issue of convertibles or warrants at the presentation of annual results or at the announcement of strategic news on mergers or takeovers. After correction for these confounding news, it is found that the announcements of neither convertibles nor warrants have any significant effect on shareholder wealth.

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LONG-TERM PERFORMANCE It is also interesting to examine the long-term performance of firms after security issues. Spiess and Affleck-Graves (1995) find significant stock price under-performance during the postequity issue years. Loughran and Ritter (1997) report that the operating performance of equity issuing firms decline afterwards. Similar decline in performance is reported by Lee and Loughran (1998) for a sample of convertible debt offerings in the US. For the Netherlands, the long-term performance is analysed by Kabir and Roosenboom (2003). They investigate if the post-issue operating performance of firms is consistent with the stock price effect observed during equity issue announcement. If raising additional capital by means of equity offerings leads to an improvement in firm’s performance, then the previously documented negative announcement effect should be considered as an anomalous finding. On the other hand, if stock price changes are forward looking and correct, then post-rights issue operating performance would show deterioration. The excess operating performance of firms subsequent to rights issue is reported in Table 7. Abnormal or excess operating performance is calculated as the difference in return on assets between issuing firm and median non-issuing firm (during the preceding five years). Median abnormal levels of operating performance for the period beginning with the year of rights issue up to five years after right issue is presented in the table. The results reveal that each performance measure is negative in post-rights issue years. Many of these excess declines are statistically significant. Equity issuing firms systematically experience an abnormal decline in subsequent operating performance. The magnitude of different post-rights issue five years cumulative average return on assets varies from –6.2% to –9.1%. The results indicate that the earlier observed value decline in the stock market at the time of announcement of equity issue comes from the expected deterioration in future operating performance of firms. These results are robust to alternative methodologies, and consistent with prior studies mainly from the United States. What could be the determinants of the decline in operating performance of rights issuing firms? Therefore, a cross-sectional regression analysis is performed where the post-issue cumulative excess operating performance of firms is used as the dependent variable. The explanatory variables are used to proxy the information asymmetry, the free cash flows and the window of opportunity hypotheses (the same hypotheses used to explain stock price performance). The cross-sectional regression results are presented in Table 8. The size of equity issue is not observed to have a statistically significant relationship with long-run firm performance. But, the

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issue-price variable is significantly positively related to post-rights issue operating performance of firms. The findings provide support for the asymmetric information hypothesis. The market to book ratio is significantly positively related to various measures of return on assets. The regression coefficient is around 0.2 and remains stable among different specifications. The observed performance decline experienced by rights issuing firms receives support from the overinvestment of free cash flows hypothesis. The relationship between the GDP growth rate and the operating performance of equity issuing firms is also examined. All but one regression coefficients are found to be statistically insignificant. Conducting tests using other proxy variables in both univariate and multivariate framework do not produce any significant result. The findings, therefore, fail to support the window of opportunity hypothesis.

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CONCLUSIONS This paper makes an analysis of corporate financing decisions of Dutch listed companies. It reviews some of the institutional features of the Dutch capital market, and discusses the empirical studies that measure the effect on shareholder wealth and long-term performance of firms. Most Dutch companies have a preference for internal funds. This is nothing exceptional. Countries with market-oriented financial system like the UK and the US also show similar pattern. Overall, there appears to be some managerial aversion to external financing either to avoid disciplining from the banks or the capital market. If external financing has to be used, there is preference for debt financing rather than equity financing. The pecking order theory of financing, therefore, receives empirical support. Dutch listed companies make rights offerings in order to attract new equity capital. The empirical evidence indicates that a significant decline in shareholder wealth takes place when companies announce rights issues. The most widely accepted explanation of this finding is that new equity issues convey information about the value of the issuing firm. Although theoretically there appears to be no incentive for managers to issue rights when the firm is overvalued, in practice it does take place. Managers possess valuable information that outside investors lack. The prevailing differences in the Dutch financial system with respect to AngloSaxon system do not result in a dissimilar stock market reaction. The post-issue performance of equity issuing firms conveys information on the real value of the firm. The empirical analysis of long-run performance suggests that companies issue shares when these are over-valued. Firms display poor operating performance for several years after they issue new equity. There are indications that firms with greater information asymmetry, higher possibilities of overinvestment of free cash flows exhibit deteriorating operating performance. An examination of shareholder wealth effect of debt financing by Dutch corporations does not reveal a statistically significant change. Similarly, announcements of financing by means of convertibles and warrants show no significant effect on firm value. Overall, the empirical evidence on the valuation effect of public security offerings in the Netherlands suggests that the prevailing differences in financial system do not lead to a pronounced different result.

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REFERENCES Bayless, M. and S. Chaplinsky, 1996, Is there a window of opportunity for seasoned issuance?, Journal of Finance 60, 253-278. Bohren, O., B. Espen Eckbo and D. Michalsen, 1997, Why underwrite rights offerings? Some new evidence, Journal of Financial Economics 46, 223-261. Brealey, R. and S. Myers, 2003, Principles of corporate finance, McGraw-Hill Irwin. Chirinko, B., H. van Ees, H. Garretsen and E. Sterken, 1998, Networks and Financial institutions in the Netherlands: corporate governance and the delta model, Working Paper, University of Groningen. Choe, H., R. Masulis and V. Nanda, 1993, Common stock offerings across the business cycle: theory and evidence, Journal of Empirical Finance 1, 3–33. De Haan, L. and J. Hinloopen, 1999, Debt or Equity? An empirical study of security issues by Dutch companies, De Nederlandsche Bank Staff Report no. 41. De Jong, A. and C. Veld, 2001, An empirical analysis of incremental capital structure decisions under managerial entrenchment, Journal of Banking and Finance 25, 1857-1895. De Jong, A., 1999, An empirical analysis of capital structure decisions in Dutch firms, Ph.D. Dissertation, Tilburg University. De Roon, F. and C. Veld, 1998, Announcement effects of convertible bond loans and warrant-bond loans: an empirical analysis for the Dutch market, Journal of Banking and Finance 22, 1481-1506. Eckbo, E., R. Masulis and O. Norli, 2000, Seasoned public offerings: resolution of the ‘new issues puzzle’, Journal of Financial Economics 56, 251-291. Gajewski, J-F. and E. Ginglinger, 2002, Seasoned equity issues in a closely held market: evidence from France, European Finance Review, Forthcoming. Gorton, G. and F. Schmid, 2000, Universal banking and the performance of German firms, Journal of Financial Economics 58, 29-80. Graham, J. and C. Harvey, 2001, The theory and practice of corporate finance: evidence from the field, Journal of Financial Economics 60, 187-243. Jensen, M., 1986, Agency costs of free cash flow, corporate finance, and takeovers, American Economic Review 76, 323-329. Kabir, R. and P. Roosenboom, 2003, Can the stock market anticipate future operating performance? Evidence from equity rights issues, Journal of Corporate Finance 9, 93-113. Kabir, R., D. Cantrijn and A. Jeunink, 1997, Takeover defenses, ownership structure and stock returns in the Netherlands, Strategic Management Journal 18, 97-109.

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Kang, J. and R. Stulz, 1996, How different is Japanese corporate finance? An investigation of the information content of new security issues, Review of Financial Studies 9, 109-139. Lee, I. and T. Loughran, 1998, Performance following convertible bond issuance, Journal of Corporate Finance 4, 185-207. Levis, M., 1995, Seasoned equity offerings and the short- and long-run performance of initial public offerings in the UK, European Financial Management 1, 125-146. Loughran, T. and J. Ritter, 1997, The operating performance of firms conducting seasoned equity offerings, Journal of Finance 52, 1823-1850. Myers, S. and N. Majluf, 1984, Corporate financing and investment decisions when firms have information investors don’t have, Journal of Financial Economics 13, 187-221. Rajan, R. and L. Zingales, 1995, What do we know about capital structure? Some evidence from international data, Journal of Finance 50, 1421-1460. Renneboog, L., 2000, Ownership, managerial control and the governance of companies listed on the Brussels stock exchange, Journal of Banking and Finance 24, 1959-1995. Roosenboom, P., 2002, Corporate governance mechanism in IPO firms, Ph.D. Dissertation, Tilburg University. Ross, S., R. Westerfield and J. Jaffe, 2002, Corporate Finance, McGraw-Hill Irwin. Slovin, M., M. Sushka and K. Lai, 2000, Alternative flotation methods, adverse selection and ownership structure: evidence from seasoned equity issuance in the U.K., Journal of Financial Economics 57, 157-190. Spiess, D. and J. Affleck-Graves, 1995, Underperformance in long-run stock returns following seasoned equity offerings, Journal of Financial Economics 38, 243-267. Tsangarakis, N., 1996, Shareholder wealth effects of equity issues in emerging markets: evidence from rights offerings in Greece, Financial Management 25, 21-32.

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TABLES AND FIGURES

Table 1 The relative position of the Dutch capital market The table compares important features of the Dutch capital market with those of some other countries. It reports information on the number of listed companies with domestic and foreign shares listed, the market capitalisation (in millions of dollars) of shares of domestic companies, and the market capitalisation (in millions of dollars) of top 10 domestic companies. The figures are for the year 2000 and those within brackets are for the year 1996. Source: FIBV

Countries

Euronext Amsterdam

Euronext Brussels

No. of companies with shares listed

Stock market capitalization

392

640

(356)

(375)

265

182

(269)

(119)

966

1447

(891)

(587)

989

1270

(-)

(665)

2364

2612

(2623)

(1642)

2862

11535

(2476)

(6842)

2096

3157

(1833)

(3011)

Top 10 market capitalization

35.3% Euronext Paris

Deutsche Börse

London

NYSE

Tokyo

44.3%

44.0%

20.0%

22.2%

29

Figure 1 Types of financing used by Dutch listed companies The table presents information on the different types of financing used by a sample of 153 nonfinancial Dutch listed companies during the period 1984 – 1997. Source: de Haan and Hinloopen (1999).

Financing Overview (1,085) Internal (485) [45%]

Private debt (221) [51%]

30

External (435) [40%]

Bonds (48) [15%]

Public equity (86) [20%]

Internal & external (165) [15%]

Combination (80) [18%]

Table 2

Capital Structure of Dutch Firms The table reports summary statistics for leverage of a sample of Dutch listed firms over the period 1992-1997. Long-term debt ratio is long-term debt over total assets. Total assets is the book value of total assets. Market value is the book value of total assets minus the book value of common equity plus the market value of common equity. Total debt ratio is total debt over total assets. Short-term debt ratio is shortterm debt over book value of total assets. Source: de Jong (1999).

Variable

Mean

Median

St. deviation

Long-term debt ratio (book value)

0.161

0.142

0.126

Long-term debt ratio (market value)

0.133

0.112

0.114

Total debt ratio (book value)

0.513

0.526

0.157

Total debt ratio (market value)

0.411

0.400

0.177

Short-term debt ratio

0.352

0.363

0.165

31

Table 3

Issue-size and issue-price of seasoned equity issues The table reports summary statistics for issue-characteristics such as issue-size and issue-price of a sample of seasoned equity offerings. Issue-size is expressed as relative to the market value of equity on the day before the announcement. Issue-price is expressed as relative to the closing stock price of one day and three days before the issue announcement as well as the average of closing stock prices for ten days before the announcement.

32

Variable

Mean

Median

Standard deviation

Issue-size

0.212

0.159

0.184

Issue-price (-1)

0.868

0.877

0.098

Issue-price (-1, -10)

0.872

0.883

0.099

Table 4

Shareholder wealth effect of seasoned equity issues The table shows cumulative average excess stock returns for various periods surrounding the announcement (day 0) of seasoned equity issues. Excess returns are calculated after adjusting for each stock’s systematic risk and are expressed in percentages. The symbols * and ** indicate statistical significance at the 10% and 5% level, respectively.

Period

Excess return

t-statistic

-60, -1

3.27

1.98*

0, +1

-2.79

-7.89**

+2, +30

-2.55

-1.76*

0, +30

-5.34

-3.71**

33

Table 5

Cross-sectional regressions of excess stock return The table reports results where the two-day announcement period excess stock return is regressed on various explanatory variables. The explanatory variables are: issue-size = the monetary amount of rights issue / market value of equity on the day before announcement; issue-price = the offer price / stock price on the day before the issue announcement; M/B = the ratio of market to book value of total assets; GDP = a dummy variable set to 1 if the issue occurs in years of relatively high growth rate of GDP. White heteroskedasticity-adjusted t-statistics are presented in parentheses below the regression coefficients. The symbols * and ** indicate statistical significance at the 10% and 5% level, respectively.

Model

Intercept

Issue-size

1

-0.01

-0.11

(-0.49)

(-2.04)**

2

-0.29 (-2.39)

3 4 5

-0.25

GDP

(2.22) -0.05

*

(-1.02)

0.17

**

0.27 (1.82)

0.17 *

0.42

0.01

(-3.97) **

(3.40) **

(0.16)

0.31

0.01

0.01

(0.27)

(0.25)

-0.34 **

-0.02 (-1.35)

Adj. R2 0.06

-0.40

(-4.38)

34

M/B

0.31

**

(-1.88)

Issue-price

(3.50)

**

0.26 0.24

Table 6

Shareholder wealth effect of different security issues The table shows excess stock returns for various periods associated with the announcement of issues of debt, convertibles and warrants. Excess returns are calculated after adjusting for each stock’s systematic risk (for debt issues) and adjusting for the stock market index return. The excess returns are expressed in percentages. The symbols ** indicate statistical significance at the 5% level.

Debt

Convertible

Warrant

Day

0.51

0.23

1.35

(-1, +1)

(0.95)

(1.01)

(2.17) **

98

47

19

-0.047

7.63

8.03

(12 months)

(8 months)

(8 months)

De Jong and Veld (2001)

De Roon and Veld (1998)

De Roon and Veld (1998)

Sample size Pre-issue excess return Source

35

Table 7

Long-run excess operating performance of companies after seasoned equity issues The table reports median abnormal levels of operating performance of firms for five years after equity issue with Year 0 used as the fiscal year of issue. The figures are expressed in percentages. Abnormal measures are calculated as the difference in performance between issuing firm and median nonissuing firm. Four different return on assets (ROA) measures: the ratios of net income to average total assets, cash flow (net income plus depreciation plus the change in current assets excluding the change in cash minus the change in current liabilities plus the change in current maturities of long-term debt) to the average of total assets, earnings before interest and taxes (EBIT) to the average of total assets, and earnings before interest, taxes and depreciation and amortization (EBITDA) to average total assets. The symbols * and ** denote significance at the 10% and 5% level (two-tailed), respectively, as indicated by the Wilcoxon signed-rank statistic.

Year 0

Year 1

Year 2

Year 3

Year 4

Year 5

Net income / Total assets

-0.5

-0.5

-1.3*

-1.1*

-1.2

-1.4*

Cash flow / Total assets

-1.5

-0.3

-3.2*

-2.0

-1.2

-0.9

EBIT / Total assets

-0.4

0.3

-0.3

-0.1

-2.1**

-2.1*

EBITDA / Total assets

0.3

-0.2

-1.3*

-2.1

-2.2**

-3.3

36

Table 8

Cross-sectional regressions of long-run excess operating performance The table reports results where the cumulative abnormal level of operating performance for five years after equity issue is regressed on various explanatory variables. The explanatory variables are: issue-size = the monetary amount of equity issue / market value of equity on the day before announcement; issue-price = the offer price / stock price prevailing one day before the issue announcement; M/B = the ratio of market to book value of total assets; GDP = a dummy variable set to 1 if the issue occurs in years of relatively high growth rate of GDP. White heteroskedasticity-adjusted t-statistics are presented in parentheses below the regression coefficients. The symbols * and ** indicate statistical significance at the 10% and 5% level, respectively.

Dependent variable Net income / Total assets Cash flow / Total assets

EBIT / Total assets

EBITDA / Total assets

Intercept

Issue-size

Issue-price

M/B

GDP

Adj. R2

-1.01

-0.03

0.82

0.18

0.03

0.14

(-2.52) **

(-0.14)

(2.20) **

(2.00) **

(0.53)

-0.81

-0.08

0.54

0.19

0.13

(-1.57)

(-0.27)

(1.08)

(1.45)

(1.94) *

-0.76

-0.17

0.54

0.21

0.06

(-2.62) **

(-1.09)

(1.84) *

(2.77) **

(1.08)

-0.86

-0.15

0.65

0.19

0.08

(-2.19) **

(-0.67)

(1.75) *

(1.90) *

(1.21)

0.09

0.14

0.11

37