The Puzzling Increase in the Underpricing of Seasoned Equity Offerings

Using a sample of over 3,000 seasoned equity offerings (SEOs) from 1983 to 1998, we test the hypothesis that the U.S. Securities and Exchange Commission's Rule 10b‐21, which disallows the covering of short positions with newly issued SEOs, makes pre‐offer stock prices less informative, which, in turn, causes the new seasoned equity to be priced at a discount. Consistent with the hypothesis, we find that the year the rule went into effect coincides with the year from which we begin observing significant SEO discounts. Further, we find that ex ante uncertainty and SEO discounts are positively related. We also conduct tests specifically related to short selling, and we also consider an exhaustive set of alternative explanations for the discounts. Based on all of the evidence, we conclude that it is the rule that makes issue discounts larger in the 1990s.