We theoretically and empirically investigate firm-level risk dynamics around seasoned equity offerings (SEOs). Empirically, beta increases before SEOs and decreases gradually thereafter. Using real options theory, commitment-to-invest generates a gradual post-issuance beta decline whereas instantaneous investment and time-to-build do not. In a behavioral theory, systematic mispricing can cause increasing pre-issuance and decreasing post-issuance risk but idiosyncratic mispricing cannot. In the empirical cross-section, investment, own-firm runup, SEO proceeds, and primary issuance--associated with the real options theory--predict beta declines. Sentiment proxies have weaker effects in the full sample, but are significant in a post-1996 subsample. SEOs coincide with low firm- and market-volatility, suggesting volatility-timing in corporate decisions. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: [email protected]., Oxford University Press.

[We theoretically and empirically investigate firm-level risk dynamics around seasoned equity offerings (SEOs). Empirically, beta increases before SEOs and decreases gradually thereafter. Using real options theory, commitment-to-invest generates a gradual postissuance beta decline whereas instantaneous investment and time-to-build do not. In a behavioral theory, systematic mispricing can cause increasing pre-issuance and decreasing post-issuance risk but idiosyncratic mispricing cannot. In the empirical cross-section, investment, own-firm runup, SEO proceeds, and primary issuance—associated with the real options theory—predict beta declines. Sentiment proxies have weaker effects in the full sample, but are significant in a post-1996 subsample. SEOs coincide with low firm-and market-volatility, suggesting volatility-timing in corporate decisions.]

We present a rational theory of SEOs that explains a pre‐issuance price run‐up, a negative announcement effect, and long‐run post‐issuance underperformance. When SEOs finance investment in a real options framework, expected returns decrease endogenously because growth options are converted into assets in place. Regardless of their risk, the new assets are less risky than the options they replace. Although both size and book‐to‐market effects are present, standard matching procedures fail to fully capture the dynamics of risk and expected return. We calibrate the model and show that it closely matches the primary features of SEO return dynamics.

We show that corporate investment decisions can explain the conditional dynamics in expected asset returns. Our approach is similar in spirit to Berk, Green, and Naik (1999) , but we introduce to the investment problem operating leverage, reversible real options, fixed adjustment costs, and finite growth opportunities. Asset betas vary over time with historical investment decisions and the current product market demand. Book‐to‐market effects emerge and relate to operating leverage, while size captures the residual importance of growth options relative to assets in place. We estimate and test the model using simulation methods and reproduce portfolio excess returns comparable to the data.

We study a dynamic corporate investment problem where decisions have to be made collectively by a group of agents holding heterogeneous beliefs and adhering to a “utilitarian” governance mechanism in which each agent has a given influence in the decision. In this setting we show that: (i) group decisions are typically dynamically inconsistent, (ii) dynamic inconsistency leads to inefficient underinvestment, and (iii) the ability to trade securities among insiders or with outsiders may restore efficient investment decisions but it may, in some cases, lead to inefficient overinvestment. Our theory can help explain the empirical evidence on the effect of diversity of groups, such as corporate boards, on firms’ outcomes and, more generally, on the difference between group and individual behavior.

We study a standard real-option problem in which sequential decisions are made through voting by a group of members with heterogeneous beliefs. We show that, when facing both investment and abandonment timing decisions, the group behavior cannot be replicated by that of a representative “median” member. As a result, members’ disagreement generates inertia—the group delays investment relative to a single-agent case—and underinvestment—the group rejects projects that are supported by a majority of members, acting in autarky. These coordination frictions hold in groups of any size, for general voting protocols, and are exacerbated by belief polarization.

We study the distinct impacts of own and rival actions on risk and return when firms strategically compete in the product market. Contrary to simple intuition, a competitor’s options to adjust capacity reduce own-firm risk. For example, if a rival possesses a growth option, an increase in industry demand directly enhances profits but also encourages value-reducing competitor expansion. The rival option thus acts as a natural hedge. Within the industry, we obtain endogenous differences in expected returns. In a leader-follower equilibrium, own-firm and competitor risks and required returns move together through contractions and oppositely during expansions, providing testable new predictions.