Intraday Market Response to Equity Offering Announcements:
A NYSE/AMEX-NASDAQ Comparison
Ronald W. Masulis*
Owen Graduate School of Management
Vanderbilt University
Nashville, TN 37203
Lakshmanan Shivakumar[*]
London Business School
London, NW1 4SA
United Kingdom
March 11, 1999
ABSTRACT
This study uses transactions data to compare the speed of price adjustments to seasoned equity offering announcements by NYSE/AMEX and NASDAQ stocks. We find that NASDAQ stocks react faster to equity offering announcements than NYSE/AMEX stocks over the first 15 minutes following the news release. The faster NASDAQ response is surprising given that NASDAQ stocks have on average a smaller offering size, lower equity capitalization and less frequent trading activity than NYSE/AMEX stocks. Further analysis suggests that the faster price reaction of NASDAQ stocks is due to several differences in market structure across the two types of markets. We find evidence that all the following conditions contribute to more rapid NASDAQ stock price adjustment: greater risk-taking by NASDAQ dealers, more rapid electronic order execution on NASDAQ, a more potent information trading threat (SOES bandits) on NASDAQ, stale limit orders on the NYSE/AMEX and a less efficient price discovery mechanism at the open of the NYSE/AMEX.
1. Introduction
This study compares the efficiency with which stock prices incorporate new information under alternative market structures. Using transactions data, we compare the relative speed of price reactions to a major corporate announcement by National Association of Security Dealers Automated Quote System (NASDAQ) listed stocks against New York Stock Exchange (NYSE) and American Stock Exchange (AMEX) listed stocks. These exchanges have distinctly different market structures, which could affect the price adjustment process. For example, NASDAQ employs an electronic listing of competing dealer quotes and the NYSE and AMEX employs a specialist system with a centralized limit order book. These and other structural differences make for an informative experiment as to whether the speed of price discovery differs across these markets and if it differs, what market features are the likely causes.
The importance of market structure has recently elicited much interest in the finance literature. However, most empirical research examining the impact of market structure on stock price behavior focuses on stock return volatility (e.g., Amihud and Mendelson (1987), Stoll and Whaley (1990), Masulis and Ng (1995)). In this study, we use several years of transactions data to examine and contrast the price, volume and bid-ask spread reactions of stocks listed on the NASDAQ with those listed on the NYSE/AMEX to a major corporate event. The corporate event we study is an initial announcement of a seasoned equity offering (SEO) by an U.S. issuer using a firm commitment underwriting contract.[1] By comparing the speed with which prices reflect new information across distinctly different market structures, we further our understanding of how trading mechanisms can aid or impede price discovery in capital markets.
To preview our results, we uncover a surprising finding, that the price adjustment process following a SEO announcement is at least 15 minutes faster for NASDAQ listed stocks than for NYSE/AMEX listed stocks. This evidence is striking given that NASDAQ stocks have smaller equity capitalization and on average are less frequently traded. We examine a number of potential explanations for this result. We find that differences in speeds of price adjustment across exchanges can not be attributed to differences in (1) the magnitudes of two-day announcement returns, (2) the frequencies of trading halts, (3) the frequencies of overnight and daytime announcements, or (4) equity capitalization or bid-ask spreads. In short, the result that NASDAQ stock prices are updated more rapidly than NYSE/AMEX prices, does not appear to be a statistical artifact of the data. It suggests that stock characteristics are relatively less important than market microstructure characteristics in explaining the differing speeds with which stock prices incorporate the economic effects of new information. On the other hand, we find evidence that a faster electronic execution system on NASDAQ, the threat of SOES bandits, the greater risk-bearing of NASDAQ dealers and stale limit orders on the NYSE/AMEX, all appear to contribute to faster price reactions by NASDAQ stocks to SEO announcements. For overnight announcements, we find that NYSE/AMEX price reactions are slowed by a relatively less efficient opening pricing mechanism.
The remainder of the paper is organized as follows. In section 2 we review institutional details, discuss our methodology and present descriptive statistics of our data. The next section presents our initial statistical results and explores possible data biases. Section 4 examines the economic hypotheses for the observed differences in price adjustment speeds to SEO announcements between NASDAQ and NYSE/AMEX stocks using univariate analysis. In section 5, we shift to a multivariate framework to more rigorously evaluate competing hypotheses. We summarize our findings and draw conclusions in the last section.
2. Institutional Details, Methodology and Descriptive Statistics
2.1 Differences in organizational structure on NASDAQ and the NYSE/AMEX
The NYSE and AMEX are order-driven continuous auction markets, the linchpins of which are market makers called specialists. Specialists facilitate continuous trading by posting quotes for their own account or by reflecting the best quotes on their limit order book, which represent a centralized depository for limit orders to buy or sell stocks at specified prices or better. Limit orders play a major role in providing immediacy and liquidity on the NYSE/AMEX as seen by the fact that over 80% (88%) of the volume on NYSE (AMEX) arise from trades in which the specialists do not participate for their own account.[2] In contrast to the NYSE/AMEX markets, the NASDAQ market is based on a competing dealer system in which each dealer continually posts firm bid and ask quotes on an electronic screen. Further, there is no central limit order book on NASDAQ, although limit orders may be left with individual broker-dealers. However, unlike the NYSE/AMEX, limit orders on NASDAQ do not drive the posted quotes since dealers are not required to consider limit orders in setting their quotes.[3] Also, dealer competition is diminished by rules allowing directed order flow to less competitive dealers who agree to meet the best quotes.
Other important institutional differences exist between the NYSE/AMEX and NASDAQ exchange systems, which may affect the speed of price adjustment. Specialists on the NYSE/AMEX are not allowed to trade ahead of limit orders at the same prices and their quotes often reflect the limit order book rather than commitments by individual specialists. This reduces specialists’ incentives to immediately adjust quotes to new information, since execution of the posted quotes often has no impact on their inventory positions or wealth. Furthermore, limit orders can not be updated instantaneously, nor can they be conditioned on public information such as the stock’s last transaction price. As a result, limit prices are temporarily stale immediately after public announcements. This slow updating of limit orders can delay revisions in the best bid and ask quotes. Moreover, hitting stale limit orders following announcements with negative price impacts may not be easy for traders in the NYSE/AMEX markets due to the uptick rule, which prevent traders from short selling on a down tick or a zero tick following a down tick. More generally, arbitrage of stale limit orders is discouraged by bid-ask spreads and the price impacts of market orders, which together can exceed the potential profits from arbitrage when information effects are modest and/or secondary markets are not highly liquid.
NASDAQ dealers must post firm bid and ask quotes for at least 1000 shares and can not rely on the limit orders of other investors. Neither dealers nor investors are constrained from short selling by an uptick rule.[4] Thus, if dealers do not immediately adjust their quotes to new information, they are vulnerable to other traders selectively hitting their stale quotes, causing them trading losses. Hence, NASDAQ dealers have strong financial incentives to revise their quotes immediately following public announcements, even in the absence of trades. These arguments suggest NASDAQ quotes should react faster to public announcements than NYSE/AMEX quotes.
The speed of market reaction to offering announcements may also differ across exchanges, due to cross-exchange differences in the speed of trade execution systems. Incoming market orders on the NYSE/AMEX are manually executed on the exchange floor to expose them to potentially new opposite market orders from specialists and floor brokers that can better the currently posted quotes.[5] In contrast, during the period examined in this study, the best price quotes of NASDAQ stocks were electronically disseminated. For orders of a 1000 shares or less, electronic execution on the SOES system was available. Thus, NASDAQ investors could often execute trades more expeditiously, but with little opportunity for price enhancement. These differences in trading mechanisms may facilitate faster execution of sell orders on NASDAQ than on the NYSE/AMEX.
For firms announcing SEOs overnight, the price setting mechanism at the open can also affect the speed of market response. Opening prices on NYSE/AMEX are set in a process resembling a call auction. More specifically, each specialist examines overnight buy and sell orders and the stock’s limit order book before choosing an opening price that crosses supply and demand. Any order imbalances at the open can be offset by the specialist trading for his/her own account or by delaying the opening of trading to allow offsetting orders to arrive. On NASDAQ the prices are set according to the usual competing dealer system, which is used through out the trading day. Prior to the official open, competing dealers tend to begin posting quotes at varying times over the prior two hours. Stoll and Whaley (1990) demonstrate that the greater market power of the specialist at the open increases the noise in NYSE/AMEX opening prices, which may slow the price adjustment process for firms making overnight SEO announcements in these markets.
One or more NASDAQ dealers are generally the underwriters of a firm’s SEO. This situation implies that one or more NASDAQ dealers can have superior information concerning impending SEO announcements if inadequate fire walls exist between the trading desk and the underwriting desk of these dealers. This information advantage is greater for daytime SEOs when other investors have no grace period to investigate the pricing implications of news prior to the commencement of trading. This potential dealer information advantage can cause the prices of these stocks to adjust more quickly to SEO announcements than otherwise. In contrast, most NYSE/AMEX specialist firms do not underwrite SEOs.
Hence, there are several institutional reasons that potentially cause differences in the price adjustment process between NASDAQ and NYSE/AMEX listed stocks. Given differences in organizational structure across exchanges, such as: the existence of a limit order book, trading rules, financial risks borne by dealers, separation or integration of broker-dealer and underwriting functions, speed of trade execution and the trading mechanism used at market open, we investigate the null hypothesis that these institutional characteristics have negligible influence on the speed of price adjustments to new information.
2.2 Measurement of intraday stock price reactions to corporate news releases
We test the null hypothesis of no differences in the average speed of price adjustment across exchange samples by analyzing stock returns in fifteen-minute trading intervals around SEO announcements. Our intraday analysis focuses on the 12 fifteen-minute intervals (3 hours) before a SEO announcement, the fifteen-minute interval containing the announcement and the 12 fifteen-minute intervals (3 hours) after the SEO announcement. Since the NYSE, AMEX and NASDAQ are generally open from 9:30 a.m. to 4:00 p.m. EST, there are 26 fifteen-minute trading intervals per trading day.
We analyze stock returns around both daytime and overnight SEO announcements. For daytime announcements, “event interval 0” is defined as the fifteen-minute trading interval containing the SEO announcement. In contrast, for overnight announcements, “event interval 0” is defined as the first fifteen-minute trading interval following the SEO announcement. All other event intervals are identified relative to interval 0. Stock returns are based on the midpoints of the best bid and ask quotes at the end of each 15 minute trading interval. The first trading interval of each day is defined as beginning at 4:00 p.m. of previous trading day and ending at 9:45 a.m. of the current day. This interval captures the return over the first fifteen-minutes of trading including opening trades, but does not distinguish between the overnight return and the return over the first 15 minutes of the trading day. Interval returns are based on the last inside bid-ask average or transaction price in the interval. For overnight returns, the last quote or price in the first 15 minute trading interval of the following day is used.[6]
Since stock characteristics such as trading activity and bid-ask spreads can affect the speed of price adjustment, we also examine the SEO announcement induced changes in these characteristics across our two exchange samples. For each trading day, we define the time-weighted spread as the average of the quoted spreads weighted by the proportion of the trading day each spread was outstanding.[7] Abnormal spreads and number of trades for an event interval i are measured as follows:
(1)
(2)
where QSPRDij is the quoted bid-ask spread for the jth quote in interval i (j=1..J), Tij is the proportion of interval i for which the jth quote is outstanding and Ki is the actual number of trades in event interval i. ASPRDi, and ATRDi are respectively the interval i time-weighted average quoted spread, and average number of trades over the benchmark period. The benchmark period consists of events days –30 to -5, where event day 0 is the SEO announcement date. Finally, DSPRD and DTRD are the benchmark period daily average spread and number of trades, respectively.[8]
For each event interval, we test the null hypothesis that mean stock returns (quoted spreads or number of trades) are insignificantly different from zero using a bootstrap resampling technique. This technique is preferred to the parametric tests since the probability distributions of intraday returns, spreads and trades are unknown. The resampling procedure used here is similar to the one employed by Barclay and Litzenberger (1988) and controls for the composition of firms and the announcement’s time of day. This procedure compares individual stock means for the same 15 minute trading interval in the event date and the benchmark period. For each trading interval, an empirical distribution is obtained by randomly sampling the corresponding 15 minute trading interval in the benchmark period. This comparison of means yields the significance level for this statistical test.