Firms issue securities for a variety of reasons, and both market practice and finance theory predict that the market's reaction to disclosure of the intent to issue new securities depends on the motivation underlying the issue and whether the motivation was already known to the market. This study investigates whether market reactions to firms' new debt issues differ depending on the motivation for the issue. In fact, prior studies, which generally have ignored the motivation of the issuer, have been unable to document economically or statistically significant market reactions to new public debt issues. We find that market reactions to new bond issues seem to be limited to those occasions where the motivation for the issue is to finance a cash flow shortfall, and the reaction is negative. This is consistent with the arguments set forth most directly by Miller and Rock. These results have practical implications for firm financial structure choices and for the investment banking process. In particular, the market seems to be able to infer the underlying reason for the need to issue securities. There is no concrete evidence of negative market reactions on outstanding debt or equity for firms using new debt offerings to fund capital investments, to change leverage, or to fund maturing debt, unless the firm also is attempting to fund unexpected cash flow shortfalls. Alternatively, only firms that are experiencing cash flow shortfalls need to be concerned that the new issues of debt will be accompanied by negative price reaction in response to information about the shortfall. We sort firms into categories that are constructed to summarize the nature of the unexpected motivation(s) and examine for differential market price responses in the different categories. With this categorization we are able to (imperfectly) characterize any new information that may be conveyed to the marketplace when the new issue details are announced. Essentially, these classifications provide a means for determining whether new information is conveyed through the announcement of the pending offering giving consideration to the fact that under some circumstances a new issue may convey good news, while in other situations bad news may be conveyed. Four motivation categories are defined according to whether the debt is issued to cover an unexpected cash flow shortfall, to finance unexpected investments in capital assets, to increase the level of debt financing used by the firm, and/or to refinance expected levels of existing debt coming due. This categorization was developed to correspond to existing theories that speak to the issue of unexpected price responses to financial structure changes. The most notable theories we examine include Miller and Rock's and Myers and Majluf's work on asymmetric information regarding the value of assets in place, tax effects associated with the shelter accorded debt financing, incentive signaling, and agency costs of debt. Approximately 400 new long-term corporate debt issues are studied, and market price responses for nearly 1,000 outstanding equity and debt securities are examined in the weeks surrounding the new issue filing. Risk- and market-adjusted measures of performance are used to assess the markets reaction. Standard abnormal returns techniques are employed to measure equity reactions. For bonds, adjustments to raw bond returns are made by subtracting an equivalent maturity Treasury return and, where sufficient data exists, by subtracting an estimate of the individual bond's risk premium. Our overall sample showed statistically insignificant negative returns of less than -0.2% for stocks and near-zero returns for bonds. Results were substantially and statistically different, however, according to the motivation for the issue. In particular, firms believed to be experiencing a cash flow shortfall in the quarter surrounding the new issue (who may have had other motivations as well) experienced abnormal returns of - 0.65% on equity and -0.4% on outstanding debt. In contrast, firms not experiencing cash flow shortfalls had announcement period abnormal stock and bond returns that were about 0.75% higher. In addition, firms with other motivations that were also motivated by a cash flow shortfall had abnormal stock returns that were about 1% lower than firms with the same motivation that did not seem to be experiencing cash flow shortfalls. Comparable results are found for the reaction of outstanding bonds. No important market reactions were observed for refinancing, capital expenditure, or change in leverage motivations either alone or in concert with one another.
