Korajczyk1992 (Chap2)

Equity Issues with Time-Varying Asymmetric Information
Author(s): Robert A. Korajczyk, Deborah J. Lucas and Robert L. McDonald

Source: The Journal of Financial and Quantitative Analysis, Vol. 27, No. 3 (Sep., 1992), pp. 397-
417
Published by: Cambridge University Press on behalf of the University of Washington School of
Business Administration
Stable URL: http://www.jstor.org/stable/2331327
Accessed: 15-02-2016 09:43 UTC
Your use of the JSTOR archive indicates your acceptance of the Terms & Conditions of Use, available at http://www.jstor.org/page/
info/about/policies/terms.jsp
JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content
in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship.
For more information about JSTOR, please contact support@jstor.org.
University of Washington School of Business Administration and Cambridge University Press are collaborating with
JSTOR to digitize, preserve and extend access to The Journal of Financial and Quantitative Analysis.
http://www.jstor.org
This content downloaded from 129.96.252.188 on Mon, 15 Feb 2016 09:43:12 UTC
All use subject to JSTOR Terms and Conditions
OF FINANCIAL
JOURNAL ANDQUANTITATIVE
ANALYSIS VOL.27, NO 3, SEPTEMBER
1992
Equity Issues with Time-Varying Asymmetric

Information
Robert A. Korajczyk, Deborah J. Lucas, and Robert L. McDonald*
Abstract
This paper develops a formal model of the effect of time-varying asymmetric information
on the timing and pricing of equity issues when managers are better informed than
outside investors. We assume that as time passes, the adverse selection problem becomes
more severe as more managers receive a private signal. Under this assumption, the
model predicts temporal variation in the quantity of issues, with a bunching of issues
after information releases. It also predicts that the price drop at issue announcement
increases with the time since the last information release. These predictions are consistent
with several recent empirical studies relating equity issues to earnings and dividend
announcements.
I. Introduction
The drop in stock prices when firms announce an equity issue is widely
taken as evidence of adverse selection in the market for new seasoned equity
(Myers and Majluf (1984)). In most discussions, the degree of information
asymmetry is fixed over time. Since information tends to arrive discretely
either through voluntary or involuntary disclosures, however, it is reasonable to
expect the degree of information asymmetry to vary significantly over time. The
purpose of this paper is to understand, in a dynamic setting, the implications of
time-varying asymmetric information on the market for seasoned equity issues.
The equity issue market is a natural place to study the effects of time-
varying asymmetric information. First, since equity is a residual claim on a
firm's assets, it is more susceptible to losses due to asymmetric information
than are more senior securities. Furthermore, the publicly traded firms that
issue seasoned equity regularly make disclosures (such as quarterly earnings an?
nouncements and dividend declarations) that can be used as proxies for discrete
information releases.
We examine the effects of time-varying information on the pricing and
timing of equity issues in a dynamic model that extends the well-known model
*Kellogg Graduate School of Management, Northwestern University, 2001 Sheridan Road,

Evanston, IL 60208-2006. Lucas and McDonald are also associated with the National Bureau
of Economic Research. The authors thank Michael Gibbons, John Hand, Rene Stulz, Sheridan
Titman, and an anonymous JFQA referee for helpful comments.
397
398 Journal of Financial and Quantitative Analysis
of Myers and Majluf (1984). Myers and Majluf attribute the drop in stock prices
when firms announce an equity issue to adverse selection. They show that firms
with favorable private information may forego the benefits of issuing equity in
order to avoid issuing at a price that reflects the fact that lower quality firms
also issue. Therefore, an equity issue signals that a firm is of below-average
quality, and the stock price drops upon announcement of an issue. The cost of
adverse selection in this context is that some firms abandon valuable projects
that require equity financing.
Under the assumption that the degree of asymmetric information is time-
varying, the magnitude of the adverse selection cost (and, hence, the size of the
price drop) is partly under the control of the firm. By choosing the timing of
an equity issue, the firm can issue when it expects relatively little asymmetric
information. Delaying the issue in this way may be costly, however, either
because the project being financed could lose value if postponed (for instance
because a competitor enters the market first), or because the firm may have to
adopt a higher cost source of interim financing.
In this paper, we examine the optimal equity issue policy of firms faced with
time-varying asymmetric information. The theory has two main predictions.
First, firms will tend to bunch equity issues after information releases, even
with costly delay of issues. However, some firms will optimally issue equity
at all times. Second, the price drop at the announcement of an equity issue
is predicted to be an increasing function of the time since the last information
release. These predictions are consistent with the findings of a number of
empirical studies.
Section II formalizes these ideas with a model in which firms with a posi?
tive net present value project choose whether or not to issue equity to finance the
project. Firms also have assets in place, the true value of which is publicly re-
vealed at regular information releases. Between information releases, managers
receive a private signal about firm value. Firms can issue equity as soon as a
project arrives, or wait until some future time to issue. The benefit of issuing
immediately is that delayed projects have some chance of "evaporating," while
the benefit of waiting until an information release is that underpricing is reduced
for high quality firms.
To understand the model, consider first the case without evaporation, so
that postponing an equity issue has no impact on project value. If all firms
were to issue equity whenever a new project arrived, the market price of equity
would be the fair price for the average firm, and equity issues would coincide
with project arrivals. However, any firm of above-average quality will find it
optimal to wait to issue equity until the market learns its true value. Thus,
the price of a firm issuing prior to an information release reflects that it is of
below-average quality. Repeating this reasoning, it follows that, in equilibrium,
all firms (except possibly the worst) wait until information is released to issue
equity when waiting is costless.1
]This, of course, is the pure "lemons"marketof Akerlof (1970). Our results are also relatedto
the idea that firms always find it advantageousto disclose all relevant informationwhen free to do
so (Grossman(1981), Milgrom (1981)).
Korajczyk, Lucas, and McDonald 399
Matters are more complicated when firms have some chance of losing the
project if the issue is postponed. Whether a firm chooses to issue immediately or
to wait depends on a number of factors: the degree of information asymmetry,
the quality of its assets, the rate at which projects evaporate, and the time until
the next information release. Immediately following an information release,
few managers will have received a new signal, so the adverse selection problem
is small and the majority of firms issue rather than risk losing their projects.
As time passes, the adverse selection problem becomes more severe as more
managers receive a private signal. At some point, only the worst firms are
willing to issue before the next information release. The net effect is that equity
issues are concentrated most heavily after information releases.
In this model, pricing and timing are related. Since the average quality
of issuing firms declines over the time between information releases, the price
drop at announcement of an issue is predicted to increase in the time since the
last information release.
This model is complementary to Lucas and McDonald (1990), who study
equity issue decisions when the information asymmetry about assets in place is
constant over time. Their model makes predictions about stock price dynamics
over a time frame of multiple information releases. This paper, on the other
hand, focusses on time-varying asymmetric information between information
releases, and the shorter run implications for the timing and pricing of equity
issues.
The remainder of the paper is organized as follows. In Sections II and
III, we develop the model and characterize an equilibrium. Section IV presents
the main results on the pricing and timing of equity issues. We discuss the
robustness of these results and the properties of other equilibria in Section V.
In practice, the announcement of an equity issue precedes the actual issue by
several weeks. In Section VI, we consider how this affects our predictions,
and derive implications for completed and withdrawn equity issues. Section
VII summarizes recent related empirical evidence that we find to be generally
consistent with the predictions of the model. Section VIII concludes.
II. The Model
In this section, we develop a model of equity issues directed toward an-

swering two questions: first, what is the aggregate distribution over time of
equity issues, and second, how are the price drops at announcement and issue
related to the timing of information releases? Initially, we assume that the an?
nouncement of an equity issue and the actual issue occur simultaneously. In
Section VI, we relax this assumption.
We make the following assumptions:
Firms. Firms are run by risk-neutral managers, who act in the interests of
existing shareholders.2 Firms have assets in place with value at at time t. The
value of assets in place changes stochastically over time, as described below.
2Investorswho plan to sell shares immediatelyafter the issue might preferthat overvaluedfirms
forego the issue. We are implicitly assuming that enough shareholdersplan to hold their shares until
Firms may also have a new project with a commonly known positive net
present value of p. Adopting a project requires k in outside capital.3 Projects
arrive randomly, at a constant aggregate rate q. A firm receives at most one
project during its lifetime.4 Unfinanced projects may "evaporate" at any time,
with instantaneous probability bdt of evaporation. Thus, the probability that a
project available at time 0 will still be available at time t is e~ht. The possibility
of evaporation makes waiting to finance a project costly.
Investors. Investors are risk neutral. They can invest in equity or an

alternative asset paying the market rate of interest, which we assume to be zero.
They always know the cross-sectional distribution of asset quality, but only learn
the asset quality of a particular firm at an information release date. Investors
can observe both project arrivals and evaporations.
Information. At fixed intervals (/ = 0,1,2,...), managers make an an-

nouncement that fully reveals the true value of existing assets to investors.5
Between times / and / + 1, managers privately learn either that their assets in
-
place have increased to at + t or decreased to az t, each occurring with equal
probability. We refer to firms that learn at + t as high quality, and firms that
learn a, ? t as low quality. Arrival of this private information about assets in
place is independent of new project arrival.
At any time i+t, t ? (0,1), a fraction p(t) of managers have learned their new
asset quality. To capture the idea that information becomes more asymmetric
over time, we assume the number of informed managers is increased over time:
dp(t)/dt > 0. Note that p(t) accommodates a variety of more specific hypotheses
about the rate of information arrival between information releases. The steeper
the slope of p, the faster the implied depreciation of the preceding information
release. The probability distribution of asset values at time i + t is summarized
in Table 1.
Investors appraise a firm conditional on the last fully revealing information
release, and whether or not it has a project. Because the intervals are identical
and there is symmetric information at the end of each interval, without loss of
generality, we can restrict attention to the interval (0, 1].
Parameter Restrictions. Finally, we make several additional assumptions.

First, we will consider only parameters such that high quality firms postpone an
equity issue until the next information release (otherwise, there is no adverse
selection problem). They will do so if there is a large quality difference between
after the next informationrelease so that this managementpolicy is supported. For a discussion of
alternativemanagerialdecision rules, see Myers and Majluf (1984).
3It is possible to allow firms to also have financial slack (e.g., cash and marketablesecurities).
However, as long as the amount of slack is publicly known, the analysis is unchanged,conditional
on the amount of observable slack. Firms with sufficient slack do not issue equity.
4We make this assumption to avoid having to take into aceount future equity issues when
computing the value of the firm. A related dynamic model of equity issues that does take future
projects into aceount is Lucas and McDonald (1990).
5Firms plan informationreleases in advance because producinga credible signal is costly, and
gatheringthe necessary informationtakes time. The existence of SEC disclosure rules requiringthe
periodic release of informationalso suggests that some informationrelease dates are anticipatedby
both insiders and outsiders.
TABLE1
Distribution of the Value of Assets in Place
Value of Assets in Place at Time / + t

(0 < t < 1) Fraction of Firms
p(0/2
1-p(0
p(0/2
high and low quality firms relative to the value of the project, if the capital
requirement is large, or if the probability of project evaporation is small. A
sufficient condition for high quality firms to postpone issuing is
(1) ^(l-e-8) <

t ?^-T.
ao + p + k
Second, in order to prove existence of the posited equilibrium, we will

assume that p{t) takes the form
(2) p(0 = (eKt-l)/(ex-l), Xreal.
This specification accommodates the benchmark case that, in the aggregate,

information arrives at a constant rate (X = 0 implies that p(t) = t).
Finally, we assume that the number of firms receiving a project in any
period is small (measure zero) relative to the total number of firms. This permits
us to treat the number of uninformed firms that potentially will receive a project
at time t as equal to the total number of uninformed firms.
III. Characterization of Equilibrium
A. Definition
We define an equilibrium in the equity issue market under the assumption

that firms follow a pure strategy of issuing or not issuing equity, and are price-
taking with respect to the terms of a sale.
Definition. An equilibrium in the equity issue market is a share, st, an issue

policy by firms, and beliefs such that
i. Investors weakly prefer to pay k for a share st of an issuing firm than to
make an alternative investment.
ii. Firms weakly prefer this issue policy to any other, taking st as given.
iii. Investors have rational expectations.
The share st is a function of investors' information at time t, and the issue policy
is a function of the manager's information.
B. An Equilibrium Issue Policy
Information becomes more asymmetric over the interval between infor?

mation releases in the sense that an increasing proportion of managers have
received a private signal. This suggests that better firms will become more
reluctant to issue equity over time as the adverse selection problem worsens.
In contrast, firms with the worst asset quality never face an adverse selection
problem and benefit by issuing immediately to avoid losing the project. With
this as an intuitive rationale, we will verify the existence of an equilibrium with
the following issue policy:
1. firms that have learned that assets are worth aH = a0 + T forego issuing until
time 1,
2. firms that have learned that assets are worth cll = ao ? t always issue as
soon as a project arrives, and
3. early in the interval between information releases, uninformed firms issue as
projects arrive, but later in the interval uninformed firms wait to learn their
asset quality before issuing.
We focus on the implications of this policy because it captures the idea that
issue behavior responds to the time-varying degree of asymmetric information.
Other equilibria are discussed in Section V
To verify that this is an equilibrium policy, we first find the ownership
share that new investors demand under the proposed policy. We then show that
no firm would choose to deviate from this policy given this ownership share.
C. Share Determination
Let Wt denote the market's expectation at time t of a firm's total asset value
net of new capital, conditional both on the availability of a project and on the
firm issuing equity at time t. Then Wt is given by
(3) Wt = ?,(<*,) +0, (0<f<l).
Et(at) is the expectation of at, conditional on all publicly available time t in?
formation. Competitive investors provide k in return for an ownership share, st.
The share is fairly priced if
(4) st = k/(k + Wt), (0<r<l).
Under the proposed issue policy, at an information release all firms with
projects issue, hence, Ei(ai) = ai and
(5) s, =
CL\+0+?
Let t denote the time in the interval at which uninformed firms cease to issue
immediately upon project receipt. Under the proposed issue policy, on (0, i) all
a^ and ao firms issue. Substituting the relative proportion of each type into (4)
implies that
(6) st = '
(l-p(0) , - p(0/2 .
ao + aL + p + jc
(l-p(0/2) (l-p(0/2)
Finally, on [?, 1) only aL firms issue, so that
k
(7) st = st =
aL + P + k
Lemma 1. Under the proposed issue policy, st is nondecreasing in t on [0,1).
Proof. See the Appendix.
D. The Decision to Issue Equity
By Lemma 1, there is no incentive for an az, firm to defer an issue since

the cost of issuing increases over time, and it may lose the project. Assumption
(1) ensures that the aH firms prefer to wait until time 1 to issue. Here we focus
on the more difficult problem of verifying that the proposed issue policy of the
uninformed ao firms is optimal.
An uninformed firm has a choice between issuing immediately or waiting
until some later date to issue. The value to the current shareholders of an
uninformed firm that issues immediately at t is
(8) (l-s,)(oo + P + *).
By Lemma 1, this is nonincreasing over time.

We will show that if an uninformed firm decides to wait, it will optimally
wait for the arrival of private information. In this case, the manager eventually
learns that assets are either high or low quality. Under the proposed issue
policy, if the project has not evaporated and the manager learns aL, the firm
issues immediately. If the manager learns aH, the issue is deferred until time 1.
Let f(t* | t) denote the probability that a firm learns its type at time f,
conditional on not having learned it by time t. Then/(/* | t) = p'{f)/{\ -
p(0),
t* > t and the expected value of waiting to issue until information arrives is
(9) X(t) = +
I(a//
2 pe-8^)
l
- c.*v?,
+ - ||(l-^)(aL iftxP + ^'
+ ^-8('*-0
[(1
2
+
(l-e-^)aL]f(t*\t)dt*
The first term in (9) is the firm's expected value if it learns that it is high quality
and postpones the issue until time 1, while the integral term is the expected value
if it learns that it is low quality and it issues upon receiving this information.
Both terms reflect the reduction in expected project value when the issue is
delayed.
Verifying that the proposed policy is optimal is accomplished by comparing
(8) to (9). In the Appendix, we demonstrate that the value of waiting for
information, (9), increases relative to the value of issuing, (8). The intuition
is that, as t increases, the probability of losing the project prior to the next
information release decreases. At the same time, the probability of receiving
useful information in the near future increases. Thus, if it is optimal to delay
an issue at all, it is optimal to delay until information arrives.
It then remains to show that (8) and (9) intersect so that early in the interval
uninformed firms issue immediately while later on they wait. This follows
from the fact that, shortly after time 0, uninformed firms issue at close to a
fair price and, therefore, gain almost nothing by waiting. Conversely, close to
time 1 uninformed firms lose almost nothing by waiting, since the probability of
project evaporation goes to zero. Theorem 1, which is proved in the Appendix,
formalizes these arguments.
Theorem 1. Assume (1) and (2). Then the proposed issue policy and share
function st satisfy the conditions for an equilibrium. Specifically, there exits a
time i,0 <i < 1 such that firms that receive a project behave as follows:
i) if a = a/,, issue immediately,
ii) if a = a//, defer issuing until the next information release, and
iii) if a = ao, issue immediately if t < i, and defer an issue decision until
becoming informed if t > i, when st is defined by (5)-(7).
This result relies on the fact that the value of waiting increases over time
for these parameters. For an arbitrary information process p(t), however, this
may not be true. Intuitively, if the rate of information arrival is irregular, it
might be worthwhile to wait for information at some points in time early in the
interval, but not at other later times.6 The role of Assumption (2) is to ensure
that the conditional rate of information arrival increases smoothly over time.
IV. Aggregate Price and Quantity Behavior
A. The Price Drop at Issue
The observed price drop at issue is the difference between the market value
of a firm with a project, and the market value of a firm with a project that issues
equity. Here we demonstrate that in the equilibrium described in Section III,
the price drop at issue increases over the interval between information releases.
It is convenient to break the unit interval into the three subintervals in
which the number of types issuing is constant. First, consider the price effect if
a firm issues at an information release date. Since the market is fully informed
about the value of issuing firms and all firms with a project issue, there is no
price drop.
For t 6 (0, t), all but the aH firms issue as soon as a project arrives. Let
V(t | a = t, issue, t < i) denote the market value at time t, conditional on the
project arriving at time t and the firm issuing at t, when t is less than t. The
market value of an issuing firm reflects the relative number of ao and aL firms
issuing,
+
= [^ <l-p???o]
(10) V(t\ a = t,issue, t<i) -?^?,-t-tt- + (3.
6For example, say that informationarrives at t = 1/2 with 95-percent probability,and that for
t e (1/2,1), a firm will not receive any information. Just before t = 1/2, it may be worthwhileto
wait, while just after t = 1/2, issuing immediately may be preferred.
For these firms immediately prior to issue,
= u preissue, t < i) = -
(11) V(t\a a0 + P (1 +
^] p^1^)^.
Since all firm types are equally likely to receive a project, the average value of
assets in place is a0. The value of the project is reduced by the probability that
an aH firm loses the project. The price drop at issue is the difference between
Equations (11) and (10).7
Lemma 4. The price drop is positive, and the magnitude of the drop increases
over the interval (0, t).
Proof. See the Appendix.
Finally, for t 6 [i, 1), there are two possibilities. Either the project has just
arrived, or it arrived at an earlier time tf,i <t' < t. In either case, the value of
the firm at issue is
(12) V(t\a = tf, issue, t > i) = aL + (3.
When the project arrives at time t > i, the market anticipates that only a^ firms
will issue immediately, that a0 firms wait for further information, and that aH
firms wait to issue until time 1. Thus, the market value of a firm conditional on
project arrival but before issue is
(13) V(t\a = t, preissue, t > i) =
The price drop at issue is the difference between (13) and (12), which we
denote by D\(t). It is easily verfied that (13) increases in r, so D{(t) increases.
For a firm at time t 6 [?, 1) whose project arrived at time t', where i <t' < t,
the market infers that the firm is either uninformed and waiting for information,
or the best type and waiting for an information release. Then the value prior to
issue is
7The market does not expect to observe an issue at time t by a firm whose project arrived at
time t1 < t < t, since this is an out-of-equilibriumissue (only a firm that learned a// would have
waited, and it would not issue until time 1). For the proposed equilibriumto be sequential, it is
sufficient to assume that if the marketdoes see an issue of this type, it believes the issuer has asset
quality ai.
P(0
(14) V(t \a = t\ pKissue, t>i) =-^~-

(aH + pe~8(1_r))
(1-P(0)
?o + e-8(I-?
?
L-S(r*-0/(r* | /}^*
Thus, the price drop is the difference between Equations (14) and (12), which
we denote by ?>2(0- Differentiation establishes that ?>2(0 also increases in time.
This establishes:
Theorem 2. Conditional on the project arrival date, the magnitude of the price
drop is increasing over the time since the immediately preceding information
disclosure.
B. The Quantity of Issues over Time
Here we characterize the model's predictions about the quantity of equity

issues over time. Clearly, a greater number of firms issue on information release
dates than at any other time, since all aH firms with a project held over from
the previous period and all firms just receiving a project, issue. The number of
firms with an accumulated project issuing at an information release date is
i
(15)
jV8a-<>P|)^.
0
Immediately thereafter, the number of issues decreases discretely, as firms that

privately learn their asset value is high again postpone issues until the next
information release date.
Over the interval (0, f), ao and a^ firms issue immediately upon project
receipt. Projects arrive at a constant rate, q. The issue rate at time t E (0, i) is,
therefore, q(\ - p(t)/2). Differentiating with respect to t proves:
Lemma 5. The number of issues decreases over time on (0,f).
At time ?, the number of firms issuing again jumps downward discretely,

as uninformed firms cease to issue as projects arrive.8 Finally, on the interval
[?, 1), firms with projects that learn aL are the only ones that issue. The rate of
issue at time t is
(16) -?(1-pW)/(H# + ^.
8With a continuumof quality types, we would expect that the number of firms issuing would
be smoothly decreasing over time.
How the number of issues varies over time after i depends on p(t). The number
may be flat, strictly increasing, or increasing and then decreasing. An increase
in the number of equity issues occurs when the rate at which firms learn that
they are the worst type is increasing (X > 0). Since after t there is no increase in
adverse selection, this increase in the number of low quality firms is not offset
by better firms dropping out of the market. Note that, if at some point in time
all firms have learned their type, the number of issues after that point is uniform.
V. Discussion
A. Robustness of Results
In this section, we discuss the motivation behind some of our main as?
sumptions, and argue that relaxing these assumptions should not change the
main implications of the theory. (The original asumptions are italicized.)
1. The new project value, p, is known with certainty. In practice, there
may be uncertainty about the value of new projects as well as about assets in
place. Interestingly, in our model, it can be shown that asymmetric information
about the value of either class of assets is enough to induce some firms to
delay issues or wait for information. This contrasts with Myers and Majluf
(1984), who show that uncertainty solely about project value does not result in
underinvestment since all firms with projects still issue. In a dynamic setting,
however, projects may be lost due to delay even in this case. We focus on one
source of uncertainty to simplify the analysis.
2. Project arrivals are observable. The qualitative effect of observability
depends on whether or not equity issues are costly. If issuing equity is costless,
then low quality firms without projects issue equity in order to pool with more
valuable firms with projects. This increases the propensity of high quality firms
to distinguish themselves by timing issues to coincide with information releases.
However, the issue price between information releases would be constant (at the
level where low quality firms without projects are indifferent about issuing).
If the cost of issuing is high enough to preclude frivolous issues, then
issues would still be clustered, and the price drop would increase as adverse
selection increases. The qualitative difference from our results is that when the
asymmetry is small, an equity issue will cause a rise in the stock price, since it
signals that a firm has a valuable project.9
3. Information releases are fully revealing. This assumption, made for sim-
plicity, implies that there is no price drop if the issue and information release
coincide. Of course, in practice, information releases are never fully revealing.
Thus, residual adverse selection will induce a price drop at issue even if in?
formation has just been released. Despite this, high quality firms will have an
incentive to wait for information releases as they expect a significant reduction
in asymmetry, and the price dynamics should be similar.
9Lucas and McDonald (1990) study a related problem in which equity issues are costly and
project arrivals are not observable. In equilibrium,high quality firms wait for informationto be
revealed before issuing.
4. All projects have the same probability ofevaporating. Korajczyk, Lucas,

and McDonald (1990a) analyze the case in which project durability is unobserv-
ably heterogeneous: some projects are perfectly durable, while others vanish if
not taken immediately. The price and quantity predictions are similar to those
here, suggesting that the basic results are robust to this type of heterogeneity.
5. Projects can only be financed by issuing equity. Generally, the pricing
distortions due to asymmetric information should be less important for senior
claims, such as debt, than for equity. Still, the existence of equity issues sug?
gests that, for some firms, equity is in fact the least-cost financing alternative.
Consider those firms that wish to finance with equity in the "long run." Un-
dervalued firms with quickly depreciating projects might use short-term debt to
postpone an equity issue. The availability of such "bridge financing" would
strengthen the quantity clumping predicted by the model, since it essentially
increases the durability of projects and, hence, the tendency for clustering of
issues.10
6. The timing of information releases is given exogenously. Even in the
case of mandated information releases such as earnings announcements and an?
nual reports, firms may hasten or delay the announcement within some window.
For instance, Chambers and Penman (1984) show that firms with good infor?
mation appear to accelerate earnings announcements. Since our theory makes
predictions that are conditional on the time since the last information release,
some ability to adjust the information release date should not affect the testable
predictions.11
B. Other Equilibria
For parameters that violate Equation (1), the model can generate qualita-
tively different predictions from those we have discussed. These equilibria tend
to occur for parameters that induce extreme behavior. For instance, if the asset
quality differential, t, becomes sufficiently small, the adverse selection problem
is dominated by the depreciation problem and all firms issue equity as soon as
a project arrives. There is no price drop at issue and no clustering of issues. At
the other extreme as t becomes large, the adverse selection problem dominates,
and only the worst firms issue equity between information releases. In this case,
issues are more tightly clustered at information releases, the quantity of issues
increases over the interval, and the price drop increases over the interval.
Even for a fixed set of parameters, the equilibrium is generally not unique.
The nonuniqueness is due to the indeterminacy of the point on the interval, i, at
which uninformed firms cease to issue when a project arrives. On a subinterval
S of (0,1), beliefs can be self-fulfilling in that, if uninformed firms believe other
10Korajczyk,Lucas, and McDonald (1990b) show that there is no increase in the debt-to-asset
ratio in the two years prior to an equity issue. This discussion suggests looking for an increase in
the ratio of short-termdebt (a proxy for bridge financing) to assets prior to an equity issue. Using
the data from that paper,we examined the behavior of both (short-termdebt)/assets and (long-term
debt)/assets. Both ratios are essentially flat preceding the quarterof the issue.
nIn the extreme case in which changing the informationrelease date is costless, our model
predictsthatthe release date would immediatelyprecedethe equity issue. This assumption,however,
does not seem reasonable.
uninformed firms will not issue after some time t 6 S, they will also prefer not
to issue. If, instead, they believe other uninformed firms will issue at t, issuing
is optimal.
This multiplicity of equilibria is consistent with the popular idea that the
number of equity issues varies according to firms' perception of the market as
"hot" or "cold." In a cold market, firms avoid issues, even though economic
fundamentals may appear to be no different from those in a hot market.
This multiplicity of equilibria cannot be eliminated by standard refinements
of Nash equilibria. However, as long as there is a single point in time at
which the uninformed cease to issue, the qualitative predictions of the model
are unaffected.12 The predicted price pattern would not obtain, however, in the
unlikely event that uninformed firms jump in and out of the issuing pool simply
as a function of time.
We have considered only pure strategies. In a related model, Giammarino
and Lewis (1988) show that, with negotiated equity financing, a semipooling
equilibrium may exist in which good firms offer shares at a fair price, and bad
firms randomize between pooling with the good firms and offering shares at a
fair price. The underwriter accepts the high price offers with probability less
than one, and always accepts the low price offers. The property that some
bad firms reveal their type depends on the assumption that if financing cannot
be obtained from the underwriter, the project evaporates immediately. In our
model, if a firm were to be denied financing, it would still retain the project
with a high probability, so there would be little incentive to reveal quality to
assure immediate financing.
VI. Price Behavior when the Announcement and Issues Do

Not Coincide
In the analysis above, we treat the announcement of an equity issue and the
actual issue as occurring simultaneously. In practice, there are usually several
weeks between the two dates. The distinction is important, in part, because it
is present in the data and, hence, must be accounted for in empirical tests, but
also because firms that have announced an issue will sometimes withdraw. Our
model helps explain how this could be optimal.
To incorporate the two dates fairly simply, in addition to the earlier as?
sumptions, we suppose that: (a) there is a known fixed interval, A, between
announcement and issue; (b) once the announcement is made, the project re-
mains available over the interval A; (c) firms can costlessly withdraw from an
announced issue; (d) credibly announcing an issue requires the payment of a
small fixed cost, C.13
When the two dates are separated, the cost of issuing ultimately depends
on the degree of adverse selection present on the issue date. The price at
announcement is based on the information revealed by the announcement about
12Theequilibriumin which the uninformedissue for as long as possible Pareto-dominatesthe

alternatives,since it implies the smallest numberof lost projects.
13Ifannouncingan issue were costless, firms would have a standingissue announcementto make
the date of issue completely flexible.
current firm quality, the anticipated degree of adverse selection on the issue date,
and the probability that the issue will be withdrawn prior to issue. Provided
that C and A are sufficiently small, and that the adverse selection problem is
severe, it is possible to demonstrate the existence of an equilibrium similar to
that described in Section VI.
Low quality firms always announce an issue, and high quality firms delay
announcing an issue until time 1-A. Uninformed firms announce issues early in
the interval and delay announcing later in the interval. There are complications
in the issue policy, however, that arise when a firm announces an issue and then
receives new information. If we break up the interval [0,1) into the subintervals
- -
[0, t- A), [i- A, 1 A), and [1 A, 1), we have the following behavior:
[0, i ? A). Type a# firms delay the announcement; type a^ and ao firms
announce immediately. Type aL firms always go through with the issue, as do
ao firms that remain uninformed. If an ao firm learns prior to issue that it is
high quality, it withdraws the issue.
This policy implies that there is a price drop both at the issue announcement
(since high quality firms do not announce) and a price drop at the actual issue
(since firms that learn they are high quality withdraw prior to issue). The
announcement date price drop increases over this interval, since an increasing
fraction of announcers are low quality.
? ?
[t A, 1 A). Only a^ firms announce an issue; all complete the issue.
The price drops at announcement but not at issue, since the issue reveals no
additional information. As before, the announcement date price drop increases
over the interval because the fraction of a// firms with projects increases over
time, raising the preannouncement price.
? A,
[1 1). All firms with projects announce an issue. Since all types
announce, there is no price drop at the announcement.14 The issue is scheduled
to occur after the time 1 information release. This implies a price drop at issue
that increases over time, since firms withdraw that have learned they are good.
The volume predictions are unchanged. A greater number of firms issue

on information release dates than at any other time. The quantity of issues is
decreasing over time until i. After i only low quality firms issue.
VII. Relation to Empirical Evidence
The well-documented price drop associated with equity issues (e.g., Asquith
and Mullins (1986), Masulis and Korwar (1986), and Barclay and Litzenberger
(1988)) is consistent with the idea that asymmetric information about firm value
has a significant impact on this market. However, this evidence is also consistent
with theories such as the price pressure hypothesis. Our model provides more
specific predictions about the relation between information-revealing events and
14Thisanomalousprediction is again due to the assumptionthat the informationrelease is fully

revealing.
the pricing and timing of equity issues that should help to isolate the role of
information.
Recall that the model predicts a higher frequency of equity issues imme?
diately after information revelation than immediately before. This is consistent
with the findings of a number of studies. The clustering of issues after infor?
mation releases is studied in Loderer and Mauer (1990), Dierkens (1991), and
Korajczyk, Lucas, and McDonald (1991). Loderer and Mauer (1990) investigate
dividend announcements, while the latter two studies use earnings announce?
ments as proxies for information releases. Loderer and Mauer (1990) find that
there are signficantly greater numbers of dividend announcements immediately
preceding, rather than immediately following, announcement of an equity is?
sue. They find that the evidence is less strong around the actual issue date.
Dierkens (1991) finds that the time between announcements of equity issues
and the preceding earnings announcement is significantly less than the time to
the following earnings announcement. Our theory makes stronger predictions
about the timing of the actual equity issue (rather than the announcement of the
issue) relative to information releases. This is investigated in Korajczyk, Lucas,
and McDonald (1991), who find that issues are more frequent early in the period
between earnings announcements, and that very few issues occur immediately
prior to an earnings announcement.
In addition, we expect the drop in market value to be larger, the longer the
time since the last information release. These pricing implications are studied
by Korajczyk, Lucas, and McDonald (1991). The abnormal stock price change
at announcement of an issue and at the actual issue date are regressed on the
elapsed time since the last information release. Consistent with the theory, they
find that the price drop increased with the time since the previous information
release, for both the announcement date and the issue date.15
In Section VI, we saw that taking into aceount the possibility that favorable
information could arrive between announcement and issue implies that some
offerings will be withdrawn. The withdrawal of announced security issues has
been studied by Mikkelson and Partch (1988). They find that 10 percent of
announced common stock issues are withdrawn. In 80 percent of the withdrawn
security offers in their sample, "unfavorable market conditions or a low stock
price" were cited as reasons for the withdrawal. Consistent with our predictions,
they find that firms that withdraw experience a price increase.
Choe, Masulis, and Nanda (1990) have developed a related model in which
they analyze the timing of equity issues relative to the business cycle. They
suggest that firms face less adverse selection at peaks than at troughs, and thus
expect to see equity issues concentrated around business cycle peaks. This
contrasts with our focus on the effect of firm-specific information.
There are certainly other sources of information in addition to the proxies
used in the studies cited above. Managers might try to use voluntary disclosures
(to the extent that they are credible) to reduce informational asymmetries before
15FromTheorem 2, the price drop is increasing in the time since the last informationrelease,
conditional on the date of project arrival. Since data are not available on project arrival,the test is
based on the strongerhypothesis that the unconditionalprice drop is increasing. In this model, the
unconditionalprice drop can be shown to increase for X > 0.
security issues. For example, Ruland, Tung, and George (1990) find that firms
whose managers release forecasts of annual earnings are almost three times as
likely (relative to a nonforecasting control group) to issue securities in the period
immediately following the forecast.
VIII. Conclusions
In this paper, we have studied the effect of time-varying adverse selection

and costly project deferral on the market for equity issues. The implied manage-
rial decision rule is more complex and arguably more plausible than the issue
policy predicted by simpler static models. If managers privately know that the
firm's assets are of sufficiently high quality, they wait for the market to become
better informed before issuing equity. Even if managers currently have no pri-
vate information, they may delay the issue until they do become informed, at
which point they decide whether to wait for the public to also become informed.
Firms with low asset quality always issue immediately, since they gain nothing
by delay and risk losing the project.
This issue policy has several testable implications. Because the good firms
delay issuing equity until their quality is revealed, we expect to see a cluster-
ing of issues after information releases. Further, because the adverse selection
problem worsens over time as more firms receive new private information, the
magnitude of the price drop at announcement of an issue, and at the issue date,
should increase over the time since the last information release. Also, with-
drawing an announced issue is construed as good news. The empirical evidence
is broadly consistent with these implications.
Appendix
Proof of Lemma 1. Equation (6) is increasing in t, and (6) is less than (7).n
Proof ofTheorem I. Since (5), (6), and (7) are constructed so that investors with
rational expectations are indifferent about investing if firms follow the proposed
issue policy, to verify that an equilibrium exists it is sufficient to show that no
firm has an incentive to deviate from the proposed issue policy.
All types have three basic choices: issue upon receipt of a project, defer
the decision until the firm becomes informed, or defer the issue until some later
date. We consider these options for each type of firm.
Firms with a = aL. For an aL firm that receives a project at time t, the
value of the firm to existing shareholders under the proposed policy of issuing
immediately is
(A-l) (l-st)(aL + $ + k).
This is greater than or equal to aL + p, since st(aL + p + k) < k for all t (by
(6) and (7)). The alternative is to wait until t1 to issue, where 1 > t' > t. The
expected value of waiting is
- -
(A-2) aL + e^^\l st>)(aL + P + ifc).
(l e-h{tl-l))
Equation (A-2) is less than Equation (A-l), since st> > st and aL < (1 -st>)(aL +
P + k), and issuing immediately is preferred.
Firms with a = a//. Because st is nondecreasing in t and because the project
may evaporate, postponing an issue until some time t1 < 1 is never optimal.
They will either defer the issue until time 1 when their value is revealed, or
issue immediately. The former is preferred if
(A-3) (l-j,)(aff + p + *) < a/, + p* -8(l-r)
A necessary and sufficient condition for Equation (A-3) to hold at t = 0 (and

hence for all t,0 < t < 1) is given by Equation (1). This proves (ii).
Firms with a = ao. We will show first that the value of issuing now as
opposed to waiting to be informed is decreasing in t (Lemma 2); second, that
there exists a t such that firms prefer to issue immediately for t < i and wait to
become informed for t > i (Lemma 3); and, finally, that it is never optimal to
defer issuing until some fixed time t1 and then issue even if the firm is not yet
informed (Lemma 3). This implies that the proposed policy is an equilibrium.
Let X(t) be the value of waiting to become informed and then following
the proposed policy if firm value will be publicly known on the issue date. This
is given by
x
i 1 /7
(A-4) X(t) = + + | t)dt
-(aH $e-h({-,))+- (aL p^'*^)/^
j
V' '
1
= +
ao+2 -^(e-Kw a-smt)),
where
(A-5) F(t) =
Jf^^-P^ds.(l-p(0)
t
For future reference, note that (9) can be rewritten
l
-
(A-6) X(t) = X(t) + X- [ (sf st*) (aL + P + k)e-^r-f)f(t* \ t)dt*.
t
Thus, if t > i, X(t) = X(t), since st = s? for t > i.

Also, define h(t) as the difference between issuing immediately and waiting
to issue,
(A-7) h(t) = (l-.s,)(ao + P + *)-X(0.
Lemma 2. (i) F'(t) > 0; (ii) X\t) > 0; (iii) h'{t) < 0.
Proof of Lemma 2.
i) Substituting for p(f) from Equation (2) and integrating F(t) yields
/^-8)_^(X-8)r x \ eix-w-t) _ 1 x
F(t) ?
\ ek - ekt (X-8)J X_g ^(i-0 _ i
Taking logarithms and differentiating gives an expression that is positive pro-

vided
\ex^
eMi-0 - 1
is increasing in X. This is verified by differentiation and noting that e^1'^-
?
[1 + X(l 0] is nonnegative.
ii) By inspection of (A-4), X'(t) > 0 if F'(t) > 0.
iii) Differentiating h(t) gives
(A-8) h'(t) = -^(a0 + P + ?-^P(8^8(W) + (l-^)F/r)

i
- + p + k)f{u | t)du
(s; su)e-h{u-'\aL
-i?
+ -(si-st)(aL + $ + k)f(t\ t)
i
- | 0 Wt - sê-îciL + P + k)f(u | t)du.
\fit
The terms in (A-8) containing integrals are positive, and F't is positive, so it
suffices to show that
(A-9) st(a0 + P + k) > -(sf- st)(aL + P + k)f(t | 0-
Differentiating (6),
-st(l-p(t))f(t\t)
(A-10) s' =
/ V
(-f)2 *?û*?
V (l-f) /
Substituting (A-10) into (A-9) and canceling positive multiplicative terms, it is

sufficient to show that
(a0 + p + ?T(l-p(0) ?+ (aL + + k)

(A-ll) s, fi > k.
/
ot+T<lzi*?+p+t
0-f)2
Substituting (6) for st and canceling like terms confirms the inequality. ?
Lemma 3. There exists a time t such that if all uninformed firms follow the
proposed policy, no individual uninformed firm has an incentive to deviate from
this policy.
Proof of Lemma 3. We first will verify that a i exists that satisfies a certain
equation, and then show that, using this i, firms will never deviate from the
proposed strategy.
Define i as the largest time t such that
(A-12) (l-a,)(ao + P + *) = X(t),
where 07 is given by the right-hand side (RHS) of (6) and X(t) is given by
(A-4). The left-hand side (LHS) of (A-12) is the value of issuing immediately
for t < i, and the RHS of (A-12) is the value of waiting for information to arrive
for t>i. By Lemma 1, LHS is nonincreasing in t, and by Lemma 2(ii), RHS is
strictly increasing in t. Thus, to show that t is well-defined, it suffices to show
that LHS (A-12) < RHS (A-12) at t = 1, and that LHS (A-12) > RHS (A-12)
at t = 0. As t i 0, the LHS ? a0 + p, and the RHS < a0 + p/2 + p^"8/2. As
t | 1, LHS ?? a/, + p, and RHS ?? a0 + p. Thus, there exists a unique i on
(0, 1) such that (A-12) holds.
Behavior on [i, 1). By the definition of i, Lemma 1, and Lemma 2(ii), and
the fact that (6) < (7) for t < 1,
X(t) > (l-a,)(ao + P + *) > (l-J?)(ao + P + ifc), t > t.
Thus, issuing is never preferred to waiting until becoming informed.

We now show that if a project arrives at t > t, it is not optimal to plan
to issue at a fixed time t' independent of information arrival. The strategy of
issuing at a fixed t1 would be preferred if
t'
(A-13) *(,) < I + \ t)df

(a?+Pe-8<>-'>) ^"gf \ \(aL+^^)f{f
t
+ - - -
l(1 ^/)(a?+p+k)e~w~t)+a? 0 e~w~f))]
jrî
In interpreting (A-13), note that (p(t') - p(f))/(l - p(0) is the probability, con?
ditional on time t, of becoming informed between time t and t'. Note also that
- -
/(** I 0(1 p(0)/(l pit')) =f(t* | t1). With some manipulation, we can rewrite
(A-13) as
(A_14)
Tô [*('V8(''~?+ aoil ~e~Ht~t))]
< " + P + k)e~^ + aL -

[d sô
JZ^ (l e-?<-?)].
Compare terms multiplying e'^''0 and l-^-8(r/_r). X(tf) > (l-^/)(a0+p+?) and
a0 > aL. Hence, the inequality is violated and waiting until t1 is not preferred.
Behavior on (0, t). By the definition of i, uninformed firms are indifferent
between waiting and issuing at i. Since the value of waiting less the value of
issuing is strictly decreasing (Lemma 2), if at any time t they do not prefer to
wait until information arrives, they will not prefer to wait at an earlier time.
Thus, on (0, t) firms do not prefer to wait until information arrives.
The remaining possibility is to wait either for information to arrive or until
some fixed time t' > t to issue. The alternative is inferior to issuing immediately
if
> (P(f0-P(0)
(A-15) (l-*)(oo + P + *) +
^(a^ Pe"8(1"?)^_p(0)
t'
+ + $ + k)e-*(t*-t)
^[(l-stl)(aL
t
+
aL*-*'*-'>]/(f*U)df*
- L
(1 p(0)
+
a0(l-e-8(;'-'))].
Subtracting X(t) from both sides of (A-15) and rearranging terms yields the
expressions preceding the first and following the last inequalities,
(A-16) (l-s,)(ao + P + *)-X(r)
l~^
> [(l-^)(ao + 8 + ?)-X(f')]
1 - p(0
>
~ Iz^l \(t _-5,0(010+
,?Uan + B
? + he-*''"*
*)*"
1-P(0 [(1
+
a0(l-e-8^)-X(/')],
where X(t) is the value of waiting at t given by (9). The first inequality in (A-
- is decreasing in t (Lemma 2) and
16) follows because (1 s,)(a0 + 3 + k)-X{t)
- - -
(1 p(?'))/(l P(0) < 1- The second follows because (1 s,)(a0 + (3 + k) > X(t)
for t < t, and X(t) > ao for all t. This proves (iii). ?
Proof of Lemma 4. By rearranging terms, the difference ((11)?(10)) can be

written
<A-17> ? **'?
S['-'('-f X1--"-")]
Comparing the term in square brackets to Equation (1) establishes that ^P(0 is
positive.
Differentiating "V(i) with respect to time yields
p(0 \ p(0
_2_88e-6<I-'>
P(f)
1" _
2 / 2
which is positive since Mty) and p' are positive. n
References
Akerlof, G. "TheMarketfor 'Lemons': QualitativeUncertaintyand the MarketMechanism." Quar?

terly Journal of Economies, 84 (Aug. 1970), 488-500.
Asquith, R, and D. W. Mullins, Jr. "Equity Issues and Offering Dilution." Journal of Financial
Economies, 15 (Jan./Feb.1986), 61-89.
Barclay, M. J., and R. H. Litzenberger."AnnouncementEffects of New Equity Issues and the Use
of IntradayPrice Data." Journal of Financial Economies, 21 (May 1988), 71-99.
Chambers, A. E., and S. H. Penman. "Timeliness of Reporting and the Stock Price Reaction to
EarningsAnnouncements."Journal of AccountingResearch, 22 (Spring 1984), 21-47.
Choe, H.; R. W. Masulis; and V. Nanda. "Onthe Timing of Seasoned CommonStock Issues: Theory
and Evidence." WorkingPaperNo. 90-30, FinancialMarketsResearchCenter,VanderbiltUniv.
(Aug. 1990).
Dierkens, N. "InformationAsymmetry and Equity Issues." Journal of Financial and Quantitative
Analysis, 26 (June 1991), 181-199.
Giammarino,R., and T. Lewis. "A Theory of Negotiated Equity Financing." Review of Financial
Studies, 1 (Fall 1988), 265-288.
Grossman,S. J. "The InformationalRole of Warrantiesand Private Disclosure about ProductQual?
ity." Journal of Law and Economies, 24 (Dec. 1981), 461-483.
Korajczyk, R. A.; D. J. Lucas; and R. L. McDonald. "The Effect of InformationReleases on the
Pricing and Timing of Equity Issues: Theory and Evidence." WorkingPaper #59, Department
of Finance, NorthwesternUniv. (April 1990a).
_"Understanding Stock Price Behavior aroundthe Time of Equity Issues." In
AsymmetricInformation,Corporate Finance, and Investment,R. Glenn Hubbard,ed. Chicago:
Univ. of Chicago Press (1990b).
"The Effect of InformationReleases on the Pricing and Timing of Equity
Issues." Review of Financial Studies, 4 (1991), 685-708.
Loderer, C, and D. C. Mauer. "CorporateDividends and Seasoned Equity Issues: An Empirical
Investigation."WorkingPaper,UniversitatBern (Nov. 1990).
Lucas, D. J., and R. L. McDonald. "EquityIssues and Stock Price Dynamics." Journal of Finance,
45 (Sept. 1990), 1019-1041.
Masulis, R. W., and A. N. Korwar. "Seasoned Equity Offerings: An Empirical Investigation."
Journal of Financial Economies, 15 (Jan./Feb. 1986), 91-118.
Mikkelson, W. H., and M. M. Partch. "WithdrawnSecurity Offerings." Journal of Financial and
QuantitativeAnalysis, 23 (June 1988), 119-133.
Milgrom, P. R. "Good News and Bad News: RepresentationTheorems and Applications." The Bell
Journal of Economies, 12 (Autumn 1981), 380-391.
Myers, S. C, and N. S. Majluf. "CorporateFinancing and InvestmentDecisions when Firms Have
InformationThat Investors Do Not Have." Journal of Financial Economies. 13 (June 1984),
187-221.
Ruland, W.; S. Tung; and N. E. George. "FactorsAssociated with the Disclosure of Managers'
Forecasts."AccountingReview, 65 (July 1990), 710-721.

Korajczyk1992 (Chap2)

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

Korajczyk1992 (Chap2)

Uploaded by

Copyright:

Available Formats

Equity Issues with Time-Varying Asymmetric Information

Author(s): Robert A. Korajczyk, Deborah J. Lucas and Robert L. McDonald

Equity Issues with Time-Varying Asymmetric

Robert A. Korajczyk, Deborah J. Lucas, and Robert L. McDonald*

*Kellogg Graduate School of Management, Northwestern University, 2001 Sheridan Road,

II. The Model

In this section, we develop a model of equity issues directed toward an-

Investors. Investors are risk neutral. They can invest in equity or an

Information. At fixed intervals (/ = 0,1,2,...), managers make an an-

Parameter Restrictions. Finally, we make several additional assumptions.

Value of Assets in Place at Time / + t

(1) ^(l-e-8) <

Second, in order to prove existence of the posited equilibrium, we will

(2) p(0 = (eKt-l)/(ex-l), Xreal.

This specification accommodates the benchmark case that, in the aggregate,

III. Characterization of Equilibrium

We define an equilibrium in the equity issue market under the assumption

Definition. An equilibrium in the equity issue market is a share, st, an issue

B. An Equilibrium Issue Policy

Information becomes more asymmetric over the interval between infor?

(3) Wt = ?,(<*,) +0, (0<f<l).

(4) st = k/(k + Wt), (0<r<l).

Finally, on [?, 1) only aL firms issue, so that

Lemma 1. Under the proposed issue policy, st is nondecreasing in t on [0,1).

Proof. See the Appendix.

D. The Decision to Issue Equity

By Lemma 1, there is no incentive for an az, firm to defer an issue since

(8) (l-s,)(oo + P + *).

By Lemma 1, this is nonincreasing over time.

IV. Aggregate Price and Quantity Behavior

A. The Price Drop at Issue

For these firms immediately prior to issue,

Proof. See the Appendix.

(12) V(t\a = tf, issue, t > i) = aL + (3.

(13) V(t\a = t, preissue, t > i) =

(14) V(t \a = t\ pKissue, t>i) =-^~-

B. The Quantity of Issues over Time

Here we characterize the model's predictions about the quantity of equity

Immediately thereafter, the number of issues decreases discretely, as firms that

Lemma 5. The number of issues decreases over time on (0,f).

At time ?, the number of firms issuing again jumps downward discretely,

4. All projects have the same probability ofevaporating. Korajczyk, Lucas,

VI. Price Behavior when the Announcement and Issues Do

12Theequilibriumin which the uninformedissue for as long as possible Pareto-dominatesthe

The volume predictions are unchanged. A greater number of firms issue

VII. Relation to Empirical Evidence

14Thisanomalousprediction is again due to the assumptionthat the informationrelease is fully

In this paper, we have studied the effect of time-varying adverse selection

(A-l) (l-st)(aL + $ + k).

(A-3) (l-j,)(aff + p + *) < a/, + p* -8(l-r)

A necessary and sufficient condition for Equation (A-3) to hold at t = 0 (and

For future reference, note that (9) can be rewritten

Thus, if t > i, X(t) = X(t), since st = s? for t > i.

(A-7) h(t) = (l-.s,)(ao + P + *)-X(0.

Taking logarithms and differentiating gives an expression that is positive pro-

(A-8) h'(t) = -^(a0 + P + ?-^P(8^8(W) + (l-^)F/r)

(A-9) st(a0 + P + k) > -(sf- st)(aL + P + k)f(t | 0-

Substituting (A-10) into (A-9) and canceling positive multiplicative terms, it is

(a0 + p + ?T(l-p(0) ?+ (aL + + k)

(A-12) (l-a,)(ao + P + *) = X(t),

X(t) > (l-a,)(ao + P + *) > (l-J?)(ao + P + ifc), t > t.

Thus, issuing is never preferred to waiting until becoming informed.

(A-13) *(,) < I + \ t)df

(A-3) (l-j,)(aff + p + ) < a/, + p -8(l-r)