Background and Motivation
Equity issuance is an event in which a firm raises a lot of capital from external financial markets. Previous studies document that U.S. firms’ cash holdings have been on the increase since 1980s. The same period has also see ...

Background and Motivation
Equity issuance is an event in which a firm raises a lot of capital from external financial markets. Previous studies document that U.S. firms’ cash holdings have been on the increase since 1980s. The same period has also seen the increase in the type of firms that face high uncertainty and turn to equity issues for financing capital (e.g., Bates, Kahle and Stulz (2009)). Hence, it is natural to imagine a link between U.S firms’ long-term ascension in cash holdings and equity issues.
The present study is motivated by our skepticism concerning McLean’s (2011) high estimate of cash-savings rate. McLean (2011) posits that U.S. firms save a high proportion of equity issue proceeds (as high as 60 percent) in cash and therefore equity issuances contribute significantly to their large cash holdings. We point out that such estimate is not compatible with some of our existing knowledge of firm behavior. First of all, cash saving or hoarding frequently raises investor concerns regarding agency problems so it is questionable that investors would supply capital to firms that intend to save as much as 60 percent of issue proceeds in cash. Graham and Harvey’s (2001) seminal CFO survey lists ten factors that affect managers’ decision to issue equity, which include equity overvaluation and maintaining target debt-equity ratio, but the list does not include cash saving or hoarding. Walker and Yost (2008) examine equity issuers’ stated uses of funds in registration files and identify three categories of uses: investment, debt repayment and general corporate purposes. So equity issuers’ stated uses of funds do not include cash saving or hoarding.
We acknowledge that there may be a gap between what firms say and what they do. However, our initial investigation of a sample of equity issuers (over the period 1990-2016) reveals that firms save much less cash than is implied by McLean’s estimate of cash-savings rate.

We propose the average cash-savings rate (ACSR) as a measure of cash savings: McLean’s measure is the marginal cash-savings rate (MCSR), which is estimated as the coefficient on equity issue proceeds from regression of the change in cash holdings for a given sample of firms. We posit that the average cash-savings rate (ACSR) is a more sensible measure of cash savings from equity issues. The ACSR is defined as the increase in cash divided by issue proceeds (Cashit/PaidInCapit) for an individual equity issue. To shed light on how McLean’s estimate can overstate the actual cash-savings rate, we compare the average and marginal cash-savings rates in equity issuance algebraically and graphically. Our exposition here is analogous to comparing the average and marginal propensities to save out of income in the economics literature. We demonstrate that because equity issuers typically allocate a portion of issue proceeds to uses other than saving cash, the MCSR overstates an issuer’s actual propensity to save (i.e., the ACSR).

Cross-sectional Determinants of the ACSR: Having established that equity issuers save much less cash than the marginal savings rate implies, we next conduct cross-sectional analysis to determine why some firms save more cash from equity issuance than others. We hypothesize that the propensity to save cash varies with issue size. To test this prediction, we partition our sample of equity issues into quintiles based on issue size as measured by issue proceeds scaled by lagged assets (PaidInCapt/TAt-1). Issue size increases at an increasing rate from Q1 (smallest issues) to Q5 (largest issues), with the size of Q5 issues especially large.

Our study contributes to the literature on cash holdings and equity issues in several ways. First, we provide evidence that equity issuers’ actual cash-savings rate is much lower than the marginal cash-savings rate implies. An estimated marginal cash- ...

Our study contributes to the literature on cash holdings and equity issues in several ways. First, we provide evidence that equity issuers’ actual cash-savings rate is much lower than the marginal cash-savings rate implies. An estimated marginal cash-savings rate as high as 0.6 (e.g., McLean, 2011) can be (mis)construed as suggesting that firms prioritize saving or hoarding cash in making equity issuance decisions. Our results indicate that this is not the case, as the average issuer allocates more of its issue proceeds to operating expenses and noncash assets than to saving cash. In particular, our results show that the primary purpose of equity issues is to finance the payment of expenses for small and medium-size issues and to finance large-scale business expansions for large issues. Given that equity issues do not tend to increase cash holdings significantly and any cash increases are only transitory, equity issues are unlikely to be a major source of the long-term increase in U.S. firms’ cash holdings as documented by Bates, Kahle, and Stulz (2009).
Second, we provide new evidence of wide cross-sectional variation in the extent to which firms save cash from equity issues. Our results suggest that “size” matters, as there is a clear division between small and large issues. Compared to small issues, large issues—especially very large issues—are conducted by firms with high market-to-book and large cash holdings. Moreover, these issues give rise to dramatic increases in operating expenses and temporary hikes in the cash level.
Third, the present study also enhances our understanding of the motivation behind equity issues, as our findings show that firms use issue proceeds primarily to finance operating expenses, instead of hoarding cash or increasing fixed assets. Previous studies document that equity issues are concentrated among small, high market-to-book, and financially young firms (e.g., DeAngelo, DeAngelo, and Stulz, 2010) and frequently exploit high stock valuations (e.g., Baker and Wurgler, 2002). However, only a few studies analyze the uses of issue proceeds and those studies do not consider expenses (or the increase in expenses) among the uses of issue proceeds.
Fourth and lastly, our findings have implications for theories on optimal cash holdings, including trade-off theory and agency theory. Trade-off theory of cash holdings assumes that firms stay deviated from optimal cash holdings if the cost of adjustment is greater than the benefit of attaining the optimal level (e.g., Opler et al., 1999). Our findings suggest that whether equity issues move firms toward or away from optimal cash levels is a moot point for small and medium-size issues, as those issues make little impacts on the cash ratios. Meanwhile, large issues (e.g., the Q5 issues) may shift firms’ optimal cash levels, rather than moving those firms toward optimal levels, given that those large issues increase the size of the firm considerably (for example, on average, the Q5 issues more than double the size of the firms’ assets). By analogy, large equity issues move the goalposts rather than moving the firms toward them. In a nutshell, our findings do not suggest that firms seek to move toward optimal cash levels with equity issues, large or small.

(ABSTRACT based on preliminary results): In this study we demonstrate that equity issuers’ actual cash-savings rates (as measured by the average cash-savings rate) are much lower than high marginal cash-savings rates (e.g., as high as 0.6 in McLean, 2 ...

(ABSTRACT based on preliminary results): In this study we demonstrate that equity issuers’ actual cash-savings rates (as measured by the average cash-savings rate) are much lower than high marginal cash-savings rates (e.g., as high as 0.6 in McLean, 2011) imply. On average, the increase in the cash ratio from equity issues is close to zero, as operating expenses are the largest use of issue proceeds. There is a wide cross-sectional dispersion of the average cash-savings rate from equity issues. While small and medium sized issues do not increase the cash ratio, large issues increase the cash ratio greatly, but only temporarily, to finance massive multi-year expense-based business expansions. Additional analyses suggest that the valuation effect of cash increases and the market share effect of large cash holdings (e.g., Faulkender and Wang (2006) and Fresard (2010)) are due in part to these large issuers’ business growth. Overall, firms do not hoard or stockpile cash from equity issues, suggesting that equity issues are not driven by the precautionary motive to save cash or desire to move toward optimal cash levels.

(Summary of preliminary analyses): Having established that equity issuers save much less cash than the marginal savings rate implies, we next conduct cross-sectional analysis to determine why some firms save more cash from equity issuance than others. We hypothesize that the propensity to save cash varies with issue size. To test this prediction, we partition our sample of equity issues into quintiles based on issue size as measured by issue proceeds scaled by lagged assets (PaidInCapt/TAt-1). Issue size increases at an increasing rate from Q1 (smallest issues) to Q5 (largest issues). We find that the propensity to save cash does indeed vary with issue size, as it increases monotonically from Q1 to Q5 issues.
To provide evidence on how equity issuers allocate issue proceeds, we assume that issue proceeds are used to (i) increase cash savings, (ii) increase noncash assets, and (iii) increase operating expenses. Our analysis reveals that, except for the largest issues (i.e., Q5 issues), operating expenses represent the largest use of issue proceeds. For the Q5 issues (the exception to this pattern), the cash increase is larger than the expense increase. However, the Q5 issuers increase not only cash but also expenses with their very large issues, which suggests that the Q5 issuers pursue large-scale business expansions that involve dramatic increases in both cash and expenses.
We conduct several additional analyses to shed more light on our results. First, we regress the average cash-savings rate on an array of variables to identify the factors that drive the cross-sectional variation in the cash-savings rate in equity issues. The regression results suggest that issue size and market-to-book have significant positive effects on the average cash-savings rate. Second, we analyze cash levels in the post-issuance period. Our analyses discussed above reveal that a significant proportion of issuers (particularly those in low and medium issue-size quintiles) do not increase cash, which suggests that cash-hoarding is not behind those issues. In comparison, the largest issues (i.e., Q5) increase cash holdings substantially. However, we find that large issues are followed by rapid declines in the cash-to-assets ratio in subsequent years. Hence, cash increases are transitory, intended to address relatively immediate cash needs (e.g., operating expenses). Taken together, the data do not support the cash-hoarding hypothesis, even for large issues.