Equity Issuance and Returns to Distressed Firms

This dissertation documents the positive relationship between financial distress and equity issuance and shows that dilution explains the low stock returns of distressed firms. When the cross-section of firms is sorted by degree of distress, the value-weighted mean of the monthly net issuance rate increases significantly from 0.05% for the safest decile portfolio to 0.95% for the highest. Moreover, the low returns of distressed firms are found only in past net issuers. The primary source of distressed equity issuances is discounted private issuances. Unlike earlier empirical studies that focus on returns to existing shareholders, I find that firms that issue equity privately do not underperform when returns of existing and new shareholders are combined. I also show that many managers avoid shareholder approval when issuing discounted equity by keeping the fraction of new shares just below the required 20% approval threshold. These findings suggest that dilution explains the low returns of distressed firms.