Do Insiders Use SEOs to
Signal Information?
Robert M. Hull, Corresponding Author
Professor of Finance
Phone: 785 670 1600; Email: rob.hull@washburn.edu
Sungkyu Kwak
Associate Professor of Economics
Phone: 785 670 1821; Email: sungkyu.kwak@washburn.edu
Rosemary Walker
Associate Professor of Economics
Phone: 785 670 2054; Email: rosemary.walker@washburn.edu
All of: Washburn University School of Business
1700 SW College Avenue; Topeka, Kansas 66621
Introduction
THIS PAPER COVERS TWO LINES OF RESEARCH:
 Insider Signaling
 Seasoned Offerings
WHO ARE INSIDERS?
 Section 16 of the Securities Exchange Act of 1934 defines
insiders as officers, directors, and beneficial owners.
 "Officer" refers to president, vice president, secretary, treasurer or
financial officer, comptroller, principle accounting officer, or any
person who does such managerial functions.
 "Director" refers to a member of the board of directors.
 "Beneficial owner" refers to a large shareholder who owns 10
percent or more of a class of registered equity shares in the firm.
Introduction (continued)
In regards to insider signaling, researchers have
investigated the effect of inside ownership on the
market's reaction to the announcements of various
corporate decisions.
These corporate decisions include:
 Stock repurchases (Vermaelen, 1981)
 Dividend initiations (Born, 1988)
 Sell-offs (Hirschey and Zaima, 1989)
 Stock splits (Han and Suk, 1998)
 Security offering announcements (Cornett & Travlos, 1989;
Copeland & Lee, 1991; Hull & Mazachek, 2001)
Introduction (continued)
The prior research focuses on either the level of inside
holdings at the time of the announcement (Hull and
Mazachek, 2001) or inside trading before and after the
time of the announcement (Copeland and Lee, 1991).
In some cases, inside changes are simply proxied by a
variable that is really just the percentage change in
outstanding common stock (Cornett and Travlos, 1989).
Findings of these studies are at time cited as being
consistent with Leland and Pyle (1977).
 However, the Leland and Pyle signaling theory advances the
notion that it is the change in insider ownership percentage
that influences stock value at the time of an announcement as
opposed to
 (i) the level of inside ownership or
 (ii) what insiders themselves do prior to or after the
announced event.
Introduction (continued)
 What insiders do prior to or after the event should not
impact the actual market response at the time of a
corporate management decision announcement such
as a seasoned offering announcement.
 To our knowledge, researchers have not examined how
actual changes in the percentage of inside ownership
impacts the announcement period returns for
seasoned stock offerings (or other corporate events for
that matter).
 Thus, an examination of the change in inside
ownership percentage is a missing gap in the research
that this paper attempts to address.
Introduction (continued)
Besides the insider signaling research, this study
covers the seasoned offering research.
The seasoned offering line of research has its
origins in a number of early empirical studies
(Masulis, 1983; Asquith and Mullins, 1986) that document
negative announcement period returns.
Regardless of the purpose of the offering, the
general consensus is that the negative news is being
signaled about the stock being overpriced.
 If this is the case, then more negative news should be
signaled if insiders are lowering their ownership
percentages.
Introduction (continued)
 Hull and Mazachek (2001) look at the amount of inside
ownership at the time of the seasoned offering
announcement.
– They find that greater levels of inside ownership can be associated
with greater negative signaling for equity and equity-like offerings.
 In regards to the strength of the market response to a
seasoned offering announcement, explanations for a
greater negative response include those associated with
– greater issue costs (Hull & Kerchner, 1996),
– smaller firm size (Bhushan, 1989),
– greater net negative agency costs (Jensen & Meckling, 1976;
Jensen, 1986), and
– greater decreases in inside percentages (Leland & Pyle, 1977).
 This paper will focus on Leland & Pyle theory while
revisiting the seasoned offering announcement period
results that are largely a phenomenon of the 1970s and
1980s.
Introduction (continued)
Unlike prior studies and keeping with the actual notion
of Leland and Pyle, our paper examines the actual
percentage change in inside holdings caused by an
announcement.
We do this for a sample of 729 seasoned offerings (SEOs)
from 1999 through 2006.
No one (to our knowledge) has investigated how the
actual change in insider percentages influences stock
price behavior either at the time of offering or for
longer time periods.
The information about the actual change in insider
percentages (brought about by the planned offering) is
revealed in the prospectus at the time of the registration
announcement.
I. Descriptive Statistics
* We identify seasoned offering announcement dates from the Investment
Dealers' Digest (IDD) and gather inside ownership data from the
prospectus filed with the Securities and Exchange Commission (SEC) as
part of a registration statement.
* Other information gathered from IDD and the company’s prospectus
include the offer price, the number of shares being offered (both
primary and, if applicable, secondary), the purpose of the offering, the
number of post-outstanding shares, and the issue costs.
* Other sources used for empirical tests include Compustat Annual Files
and CRSP Daily Return Files.
I. Descriptive Statistics (continued)
– We get return data from the CRSP Daily Return
Files.
• When checking to see if abnormal returns render the
same results as raw returns, we utilize the OLS market
model procedure described by Brown and Warner
(1985) to calculate cumulative returns.
– When applying this model, we compute alpha
and beta parameters using the equal-weighted
CRSP NASDAQ, AMEX, and NYSE indices for
respective NASDAQ, AMEX, and NYSE firms.
– The comparison period includes the 500 trading
days before and after the announcement day.
I. Descriptive Statistics (continued)
• For inclusion in the sample for empirical tests, an observation must
satisfy the following five screens.
– First, it must be a seasoned stock offering that is announced in the
Investment Dealers Digest.
– Second, we must be able to obtain its prospectus.
– Third, the prospectus must have inside ownership percentage
data before and after the announcement.
• The inside data includes the combined percentage holdings of all
officers & directors and the percentage holdings of all beneficial
owners who own & control at least five percent of the outstanding
shares either by themselves or through other family members or
through control of other entities that own shares.
– Fourth, it must have available stock return data needed to
perform statistical tests.
• While some tests require other data, observations without the
required data can be lost for these tests.
I. Descriptive Statistics (continued)
• After applying these screens, we have 729 seasoned
stock offerings remaining from
– the 1,601 for which we could find prospectuses, and
– the 2,371 firms identified from IDD.
• Table I provides descriptive statistics for our sample
of 729 offerings that occur for the seven years and
three months from January 1999 through March
2006.
• The time period statistics in Table I reveal that
about 40% of the observations occurred in 19992000. This can be at explained by the fact that the
stock market was peaking during these two years.
Key Variables
Mean
Median
Range
Percentage of Inside Ownership Before
48.76%
45.60%
1.30% – 100.0%
Percentage of Inside Ownership After
38.04%
34.10%
0.00% – 100.0%
Change in the Percentage of Inside Ownership
-10.72%
-9.10%
-42.00% – +7.75%
Total Shares Offered (Primary plus Secondary)
6.766M
4.250M
0.550M – 135.1M
Secondary Shares as Percentage of Total Shares
39.16%
24.72%
0.00% – 100.0%
Offer Value (Offer Price × Total Shares Offered)
211.60M
109.14M
5.00M – 8,782M
Common Value
2,164.6M
719.7M
20.3M – 46,134M
Offer Value as Percentage of Common Stock Value
16.20%
14.62%
0.00% – 223.0%
Firm Value
5,430M
1,039M
31.0M – 340,121M
Issuance Expenses as Percentage of Offer Value
5.73%
5.69%
0.00% – 23.00%
Issuance Expenses as Percentage of Common Value
0.98%
0.82%
0.00% – 7.00%
Two-Day Return (Days -1, 0)
-1.51%
-1.32% -35.32% – +42.43%
Three-Day Return (Days -1, 0, +1)
-0.99%
-1.31% -49.00% – +52.00%
Four-Day Return (Days -2, -1, 0, +1)
-1.53%
-1.46% -58.42% – +48.93%
131.78%
53.66% -99.4% – +3408.7%
24.09%
3.07% 2.68% – +221.19.7%
Four-Year Firm Returns around Day 0 (n = 621)
Four-Year Market Returns around Day 0 (n = 654)
I. Descriptive Statistics (continued)
• Table I next reports statistics for key variables.
– The mean (median) inside ownership percentage before the
announcement is 48.76% (45.60%), while after the offering
the mean (median) values are 38.04% (34.10%).
– The mean (median) change in the percentage of inside
ownership is -10.72% (-9.10%) indicating that a typical firm’s
insiders decrease their percentage ownership by about ten
percent.
– Another statistic from Table I deserving more emphasis is the
number of shares sold by current owners (which includes
insiders).
• The mean (median) for this statistic is 39.16% (24.72%).
– The mean (median) percentage change in common stock
value is 16.20% (14.62%) indicating that firms are selling
about $1 of shares for every $6 or $7 dollars in current value.
I. Descriptive Statistics (continued)
• Table I also reports issuance expenses data as given in the prospectus,
which consists mostly of the underwriting discount.
– These expenses do not include other perks such as warrants, money
from exercising overallotment options, underpricing, and other
miscellaneous expenses (like employees’ time).
• Prior research (Hull and Kerchner, 1996) finds that underpricing can
range from 1/2 – 2/3 of the expenses reported in the prospectus.
• The OTC research (Hull and Fortin, 1994) suggests that all other
expenses can equal that reported in the prospectus.
– Thus, it appears that issuance expenses given in Table I (which is about
1% of common stock value) can explain most, if not all, of the fall in
stock value at the time of the announcement.
– This is because Table I reports that fall ranges from about -0.99% to
about -1.53% depending on which days are used when computing the
announcement period return.
• For the two-day return (which is the return commonly used) the mean
(median) return is -1.51% (-1.32%).
I. Descriptive Statistics (continued)
• Finally, as seen in Table I, the typical firm experiences
positive returns for the four years around their
seasoned offering.
– These four years include the two years prior and the two
years after the offering.
– The mean (median) four-year return is 131.78% (53.66%).
The mean (median) return on a comparable market index is
only 24.09% (3.07%).
– Although the results may be biased due to losing 108 firms
without sufficient stock price data, the return is positive
enough to indicate that the recent time period used in this
study (1999-2006) gives long-term returns for seasoned
offerings similar to prior studies.
– Thus, we verify prior conclusion that stock offerings tend to
take place during periods when the stock is doing well and/or
overpriced.
Panel A. Announcement Period Return Results
Sample
Number of Mean Change in Inside
Mean Two-Day Return
Companies Ownership Percentage (Range) (Range)
All Portfolios
729-10.72% (-42.00% – +7.75%)
-1.51% (-35.32% – +42.43%)
Portfolio 1
243-3.05% (-5.80% – +7.75%)
-1.69% (-35.32% – +31.19%)
Portfolio 2
243-9.12% (-12.50% – -5.90%)
-1.20% (-31.82% – +42.43%)
Portfolio 3
243-19.99% (-42.00% – -12.50%)
-1.63% (-24.65% – +26.42%)
Panel B. Tests for Equality of Portfolio Returns
Test
Portfolios
Compared
Test Statistic
F-test
1, 2, and 3
0.24
t-test
1 and 2
0.61
t-test
2 and 3
0.57
t-test
1 and 3
0.08
II. Return Results
To investigate whether returns are more negative
for firms with greater decreases in inside ownership
percentages, we partition our seasoned offering
sample into three portfolios.
Portfolio 1 includes firms with the least changes in
inside ownership percentages.
Portfolios 2 and 3 consist of firms with the middle and
greatest changes in inside ownership percentages,
respectively.
Signaling theory rooted in Leland and Pyle (1977)
predicts that Portfolio 1 will have the least negative
return and Portfolio 1 will have greatest negative
return.
II. Return Results (continued)
• Table II provides mean two-day announcement period returns for
days -1 to 0.
– The first row in Panel A reports that the two-day return of -1.51% for the total
sample is statistically significant (t = -4.76).
– The last three rows in Panel A provide two-day return results for the three
portfolios. Inconsistent with signaling theory, these rows reveal that returns
do not decrease monotonically with the decrease in inside ownership
percentages.
– The least negative return is -1.20% (t = -2.12) for portfolio 2, in which the
change in inside ownership percentages ranges from -12.50% to -5.90%.
– For portfolio 1, the return is the most negative at -1.69% (t = -2.93) even
though the change in inside ownership percentage only ranges from -5.80% to
+7.75%.
– For portfolio 3, the return is similar to portfolio 1 with a return of -1.63% (t
= -3.25) even though the change in inside ownership percentages range
from -12.40% to -42.00%.
– In conclusion, the respective means (medians) for the change in inside
ownership percentages of -3.05%, -9.12%, and -19.99% for portfolios 1, 2, and
3 do not render two-day return results predicted by signaling theory.
II. Return Results (continued)
• Panel B in Table II reports statistical results when
comparing portfolio two-day returns and confirm
the conclusion generated from Panel A.
• The first row provides analysis of variance results
when testing whether returns are identical across
portfolios.
• The F-statistic of only 0.24 reveals that returns are
not significantly different across portfolios.
• Although not presented in table format,
comparable results are found when the sample is
partitioned into either four or five portfolios.
II. Return Results (continued)
The last three rows in Panel B report nonpaired
one-tailed parametric t-statistics when testing
the null hypothesis that the return for the
portfolio with the lesser decreases in inside
ownership percentages is more negative or equal
to the return for the portfolio with greater
decreases in inside ownership percentages.
Comparisons between any two portfolios do not
reject the hypothesis that returns are equal.
In fact, the t-statistics are all rather anemic
offering no support for Leland & Pyle (1977).
II. Return Results (continued)
• The results in both panels of Table II offer evidence
that the wealth effects do not differ across firms
with dissimilar inside ownership percentages.
• Inconsistent with signaling theory based in Leland
and Pyle (1977), seasoned offering announcement
period returns by companies with greater decreases
in inside ownership percentages are not associated
with greater negative returns.
• Thus, investors in firms undergoing seasoned
offerings cannot expect a more negative market
response as the inside ownership percentages
decreases.
III. Other Tests and Results
• We conduct a number of other tests.
– First, we repeat prior research by looking at the level of inside ownership.
– Consistent with this research, we find that the strength of the market response
increases as the level of inside ownership increases.
– For the percentages of inside ownership after the offering as given by the
prospectuses, we find that the mean values for the percentage of inside ownership
for portfolios 1, 2, and 3 are 15.29%, 34.42% and 64.47%.
– These three portfolios (ranked according the level of inside ownership and not the
change in inside ownership percentage) renders mean two-day returns
of -0.57%, -1.49%, and 2.46% for portfolios 1, 2, and 3.
– The F-statistic for the two-day return is 2.97 (significant at the 5% level).
– For four-day returns, portfolios 1, 2, and 3 have returns of -0.17%, -1.05% and
3.37% with an F-statistic is 5.73, which is significant at the 1% level.
– The three-day return has the highest F-statistic at 5.73.
– Finally, considering the t-tests for portfolios 1 and 3, which should have the greatest
differences, the two-day, three-day, and four-day returns have t-statistics of 2.42,
3.31, and 3.06 (all significant at the 1% level).
– These results suggest that investors will disregard changes in inside ownership
percentages at the time of the seasoned offering if they still maintain high
ownership levels after the offering.
III. Other Tests and Results (continued)
• Besides the above tests, we also ran a number of other tests.
• For example, the results using three-day returns and four-day returns
are similar to the two-day returns reported in Table II with all F and ttests insignificant.
• Similarly, adjusting for expected returns using various models do not
change our results.
• In addition, we repeated our tests by deleting observations that are
typically omitted such as REITs, financials and utilities.
– Deleting these observations do not change our results, which may be explained by
the fact these firms do not dominate any of the portfolios.
• Similarly, adjusting for issuance costs following the methodology of prior
research (Hull and Fortin, 1994; Hull and Kerchner, 1996) does not change
our findings.
– Once again, it is because the issuance costs are similar for all portfolios.
• Finally, a number of tests indicate that firm size is not a significant factor
in explaining our conclusions regarding the change in insider
percentages.
III. Other Tests and Results (continued)
• Finally, we conducted some tests on betas and long-run returns where returns
were adjusted based on betas and also matching NASDAQ, AMEX or NYSE indices.
• One striking finding involves a statistically significant relationship between betas
and changes in insider ownership proportions.
– Firms undergoing greater insider changes have lower betas.
• Long-run return findings include
– Firms where insiders are undergoing greater changes perform poorer before the
seasoned offering announcement.
• Holds for one, two, and three year periods and is statistically significant at 1% level for
one year period (marginally significant for other periods).
– Firms where insiders are undergoing greater changes perform better after the
seasoned offering announcement.
• Holds for one, two, and three year periods and statistically significant for each period
at 1% levels, respectively.
• Two possible interpretations of long-run return findings:
– Insiders sell a higher proportion of their shares when the company has inferior
returns the year prior and in the process show no understanding of the relative
superior future prospects of their own companies
– Insiders sell a higher proportion of their shares because they are conservatively
diversifying their own holdings all the while still maintaining higher levels of
ownership where this higher level really reveals what they think about their firms’
future performances.
IV. Summary
 Prior research, not only in security offerings
announcements but also other areas of corporate
announcements, indicates that inside ownership is an
important determinant of how the market reacts.
These studies often focus on either the level of insider
holdings or insider trading around the time of the
offering.
 This paper examines actual changes in inside holdings
for seasoned offerings, which is the inside information
that tells us more precisely what insiders feel about
the company.
This information can be revealed at the time of the
registration announcement when the prospectus states
exactly what insider ownership percentages are expected
to be both before and after the offering.
IV. Summary (continued)
In examining prospectuses for 729 seasoned offerings
from 1999 through 2006, we find surprising and
unexpected results.
In particular, we discover no relationship between changes
in inside ownership percentages and how the stock prices
responds.
We attribute the difference in our results to the fact that
the market looks at the level or percentage of ownership
and not how the percentage changes.
This appears to be an anomaly because signaling theory
rooted in Leland and Pyle (1977) specifies that the change
in insider percentages should reveal what insiders think
about the firm’s prospects.
By simultaneously lowering their ownership proportions,
yet selling at a premium value, it appears that insiders are
able to maximize their own welfare at the expense of
current and newer shareholders.
IV. Summary (continued)
• Practically speaking, our findings can guide managers in
terms of what to expect when announcing a seasoned
offering where insiders are also selling (or at least not
buying).
– For example, if inside holdings are already high and remain at
relatively the same level, then investors appear to be
unconcerned about insider behavior.
• Investor concern may also be mitigated due to the fact
the firms undergoing seasoned offerings perform
relative well for the four years surrounding the offering
compared to benchmark market indices.
• If investors believe the firm is already in safe hand, then
insider behavior is less of a concern.