Analyzing the impact of raising financing on cumulative abnormal stock returns among Indian corporates

Abstract

Several empirical researches have been carried out in advanced economies to determine the impact of raising financing by the corporates on their stock price. Various modes of financing that have often been compared are: 1. Raising debt from market through private placement. 2. Raising debt publicly. 3. Bank loans and guarantees (Lines of Credit). Based on these empirical researches it has been found that, raising financing through bank loans and guarantees (whether a new loan or a loan renewal2) yields a positive abnormal stock returns while doing it through debt markets leads to a zero or negative abnormal returns. Therefore, it can be said that getting a loan approved from the bank increases shareholder’s wealth in advanced economies. The reasoning, as proposed by economists is that a bank loan provides the corporates free advisory and monitoring from the bank which increases the probability of success of the project by reducing moral hazard. This is absent in the case of debt markets financing. Bank loans and guarantees work well in case of advanced economies due to arm’s length relationship between the banks and corporates. This leads to an objective evaluation of each loan application thereby avoiding adverse selection. The credibility of a corporate in advanced economy taking a bank loan can thus be assumed to be the same as a corporate that raises money through debt markets. However, this scenario is not the same in developing economies3 particularly India where a large chunk of banks is state owned. This leads to state intervention in giving out bank loans thereby compromising the objectivity that exists in developing economies. The purpose of this project is to compare the two modes of financing in India (Public debt and debt through private placements) and test the hypothesis that private placements yield higher positive abnormal returns as compared to raising funds through public debt. The rationale behind this is that the investors in case of private placements are few and hence are able to monitor the performance of the borrower as compared to public debt where the investors are many and scattered to be able to monitor the performance.