Economic Modelling xxx (xxxx) xxx

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Economic Modelling
journal homepage: www.journals.elsevier.com/economic-modelling

Investor sentiment and stock price: Empirical evidence from Chinese SEOs☆
Yueqin Lan a, Yong Huang b, *, Chao Yan b
a
School of Economics and Finance, Huaqiao University, Quanzhou, FuJian, 362021, China
b
School of Accounting and Finance, Zhongnan University of Economics and Law, Wuhan, Hubei, 430073, China

A R T I C L E I N F O A B S T R A C T

JEL classification: We examine whether and how the market interacts with investor sentiment in the context of seasoned equity
G14 offerings (SEOs) by Chinese listed firms. We adopt the component of market index return, which cannot be
G18 explained by fundamental macro-economic factors as a proxy for the market-wide investor sentiment, and
G32
overnight stock returns proxying for the firm-specific sentiment. We find robust evidence that investor sentiment
Keywords: drives the pre-announcement abnormal return. In the post-announcement period, the market corrects the
Investor sentiment
sentiment-driven overvaluation within about one month. These findings reinforce the view that market timers
Seasoned equity offering
Overvaluation
take advantage of investor sentiment to issue seasoned shares.

1. Introduction taking advantage of insights from the behavioral finance literature.

This paper investigates whether and how the stock prices and investor
sentiment interact with each other in the seasoned equity offering (SEO)
market. A stylized fact in the finance literature is that SEO announce-
ments are preceded by a sharp run-up in the stock price and followed by a
negative market reaction (Asquith and Mullins, 1986; Chen et al., 2019;
Carlson et al., 2006; Hertzel and Li, 2010; Loughran and Ritter, 1995). A
common explanation for this phenomenon is that managers with access
to inside information take advantage of the temporary overvaluation
opportunities. Thus, SEO announcements are generally interpreted as a
signal that the firm's shares are overvalued (Bilinski and Strong, 2013;
Loughran and Ritter, 1995). However, it is still unclear whether stock
prices before SEO announcements are really overvalued, how efficient
the market is in correcting the pre-announcement misvaluation, and
whether the market's correcting behavior has any (unintended) effects.
For example, previous works cannot rule out the possibility that man-
agers announce SEOs when they get access to profitable investment op-
portunities (i.e., real options), and that stock prices then decline due to a
reduction in the volatility associated with the underlying assets of the
real option (Carlson et al., 2006).
To the best of our knowledge, only a few studies explicitly examine
whether pre-SEO announcement stock prices are overvalued and how
efficiently the market correctly the misvaluation from the perspective of
investor sentiment. This paper attempts principally to fill this void by
Investor sentiment, which is characterized by moods, emotions, atti-
tudes, and investor opinion, is a broad notion representing any misper-
ception that can cause mispricing (Chang et al., 2012; Kaplanski and
Levy, 2010; Yang and Li, 2013; Zhou and Yang, 2019). Baker and Wur-
gler (2006) define investor sentiment as a misguided belief about a firm's
risks or future cash flows, that is unjustified in terms of the information
available. The burgeoning literature on behavioral finance suggests that
investor sentiment has a significant impact on stock returns and gener-
ates mispricing (Baker and Stein, 2004; Baker and Wurgler, 2006; Bar-
beris et al., 1998; Brown and Cliff, 2005; Corredor et al., 2013; De Long,
Shleifer, Summers, and Waldmann, 1990; Kaplanski and Levy, 2010;
Kling and Gao, 2008; Renault, 2017; Schmeling, 2009). Supporting these
arguments, we premise that stock price run-up preceding SEO an-
nouncements reflects the overvaluation that is attributable to investor
sentiment. We examine whether investor sentiment drives up
pre-announcement abnormal returns, and generates a decline in
post-announcement returns. Such analyses are critical for examining
whether investor sentiment underpins the stock price movements sur-
rounding SEO announcements.
We follow Baker and Wurgler (2006) approach in spirit and employ
the error terms of market regression to construct the market-wide
investor sentiment variable. Specifically, we first implement a
time-series regression of market return and employs a set of fundamental
macro-economic variables as independent variables. Then, we take the

☆
This research has been financially supported by the National Natural Science Foundation of China (Grant No. 71702191 and 71902187) and the Fundamental
Research Funds for the Central Universities of the Zhongnan University of Economics and Law (Grant No. 2722020JCG053).
* Corresponding author.
E-mail addresses: lanyq@126.com (Y. Lan), huangyong@zuel.edu.cn (Y. Huang), chaoyan@zuel.edu.cn (C. Yan).

https://doi.org/10.1016/j.econmod.2020.02.012
Received 1 December 2019; Received in revised form 28 January 2020; Accepted 3 February 2020
Available online xxxx
0264-9993/© 2020 Elsevier B.V. All rights reserved.

Please cite this article as: Lan, Y. et al., Investor sentiment and stock price: Empirical evidence from Chinese SEOs, Economic Modelling, https://
doi.org/10.1016/j.econmod.2020.02.012
Y. Lan et al.
error term of the regression as the proxy for market-wide investor
sentiment (i.e., sentiment-driven market return). The expected value of
market index return (i.e., fundamental-driven market return) is also used
in our analysis to examine whether fundamental conditions affect the
stock price movements surrounding SEO announcements. In addition to
market-wide investor sentiment, we capture firm-specific investor
sentiment by relying on Aboody, Even-Tov, Lehavy, and Trueman's
(2018) overnight return variable. We employ a two-step regression to test
the overvaluation hypothesis. In the first step, we regress the
pre-announcement returns against the fundamental-driven market
returns, sentiment-driven market returns, firm-specific overnight returns,
and decompose the pre-announcement return into fundamental- and
sentiment-driven components. In the second step, we regress the
post-announcement return against the fundamental- and
sentiment-driven pre-announcement returns.
We exploit Chinese firms’ SEOs announced and executed during the
period 2006 to 2013 to address the issue. The Chinese stock market is an
emerging market dominated by retail investors (Jiang and Kim, 2015; Li
and Wang, 2010), among whom sentiment has a strong impact on stock
returns (Bu and Pi, 2014; Chi et al., 2012; Kling and Gao, 2008; Lee et al.,
2014; Qiang and Shu-e, 2009; Truong, 2011).1 More importantly, Chi-
nese SEOs experience a much longer period of time from the initial
announcement to final execution than the US firms. This is because
Chinese firms need to apply for government approval before the final
execution. The long interval ensures that the downward pricing pressure
generated by actual execution of SEOs does not contaminate
post-announcement returns associated with potential investor sentiment,
and thereby enables an accurate investigation of announcement effects.
Our main findings are summarized as follows. Firstly, we confirm that
a negative and significant relationship exists between pre- and post-
announcement cumulative abnormal returns (CARs) among our sample
SEOs. Notably, the pre-announcement CAR is positively related to the
sentiment-driven market return and firm-specific overnight returns.
However, we do not observe a stable and statistically significant associ-
ation between post-announcement CARs and fundamental characteris-
tics. These results clearly suggest that stock prices of SEO firms are
overvalued before the announcement and the overvaluation is driven by
investor sentiment. Then, we decompose the pre-announcement CAR
into fundamental- and sentiment-driven CAR by using the estimation
results in the first-step regressions. The post-announcement CAR is
negatively related to the sentiment-driven pre-announcement CAR and
positively to the fundamental-driven pre-announcement CAR. Estimated
coefficients suggest that the pre-announcement price run-up, which ari-
ses from investor sentiment, mostly disappears within one month after
the announcement. These results are robust to the choice of CAR esti-
mation methods and sentiment variables. We argue that the well-known
negative relation between pre- and post-announcement returns is driven
by overvaluation, which is associated with investor sentiment. This
finding reinforces the view that managers take advantage of investor
sentiment to conduct SEOs.
This paper makes significant contributions to the literature. By taking
advantage of recent developments in behavioral finance research, we
examine the existence and effects of overvaluation from the perspective
of investor sentiment in the context of SEOs. We document strong evi-
dence of the overvaluation hypothesis. Hertzel and Li (2010) construct a
proxy for overvaluation by decomposing the market-to-book ratio into
three components: firm-specific error, sector error, and long-term val-
ue-to-book. However, the decomposition approach needs annual
1
Institutional investors as commonly viewed as arbitragers, but arbitrages are
likely limited in China due to the dominance of retail investors. Truong (2011)
and Chi et al. (2012) attribute the strong impact of investor sentiment in China
to the fact that the Chinese stock market has a short history and investors are
less experienced. Qiang and Shu-e (2009) note that speculation prevails among
Chinese investors due to imperfections in laws and institutions.
2
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accounting data and inevitably generates a few-month gap between the
measurement of overvaluation and SEO announcements. In contrast, our
investigation directly examines stock price movements surrounding SEO
announcements and presents clear evidence that stock prices increase
due to pre-announcement overvaluation, and that the pre-announcement
price run-up mostly disappears in the post-announcement period. To the
best of our knowledge, our research is the first to show evidence that the
stock price movements surrounding SEO announcements are attributable
to the sentiment-driven overvaluation and the corresponding correction.
It would also be noteworthy that we present empirical analyses of SEOs'
announcement effects in a market where the actual execution of SEOs is
less likely to affect post-announcement stock returns. Finally, our results
are closely related to Brown and Cliff's (2005) finding that high sentiment
generates concurrent overvaluation and ensuing reversal. This paper
shows evidence that the same phenomenon occurs surrounding Chinese
firms' SEO announcements.
The rest of the paper is organized as follows. Section 2 reviews the
literature and develops the hypothesis. Section 3 describes sample se-
lection procedures and construction of the investor sentiment variable.
Section 4 presents our main empirical results. Section 5 presents addi-
tional analyses. Section 6 concludes the research.
2. Literature review and hypothesis
Assuming managers have private information for future cash flow,
finance theory suggests that firms tend to issue shares when they are
overpriced (overvaluation hypothesis) (Baker and Wurgler, 2002; Brea-
ley et al., 1976; Dissanaike et al., 2014; Hovakimian et al., 2001; Jung
et al., 1996; Marsh, 1982; Myers and Majluf, 1984; Taggart, 1977). The
overvaluation hypothesis predicts that stock prices show a negative
response to the announcement of SEOs. For US primary equity offerings
between 1963 and 1981, Mikkelson and Partch (1986) found that the
two-day CAR on the announcement was
3 percent (day 0 is
announcement day). Loughran and Ritter (1995) and Carlson et al.
(2006) also report a significant stock price reduction on SEO an-
nouncements. Previous studies also suggest that SEO firms show poor
long-term performance. Asquith and Mullins (1986) report a downward
drift (about six percent in cumulative excess returns) for 480
post-announcement trading days. Carlson et al. (2010) show that the
average issuer earns a 10 percent buy-and-hold return compared to 28.6
percent and 38.6 percent returns for size and book-to-market matching
portfolios. These findings are consistent with the underlying idea that
managers know firms’ future cash flow better than outside investors.
Indeed, previous studies show that managers successfully time the mar-
ket: Baker and Wurgler (2002, 2000), Cohen et al. (2007), and DeAngelo
et al. (2010) for SEOs; Brockman and Chung (2001), Cook (2003),
Ginglinger and Hamon (2007), and Zhang (2002) for repurchases.2
The overvaluation hypothesis also predicts that stock prices increase
before SEO announcements and that pre-announcement returns are
negatively related to post-announcement stock returns. Asquith and
Mullins (1986) report that the CAR from day
490 to day
10 is 40.4
percent. DeAngelo et al. (2010) find that 70 percent (60 percent) of 4291
US SEOs during the period from 1973 to 2001 have positive abnormal
returns over the 12- (36)-month period preceding issuance. Kim and
Purnanandam (2013) find that SEO firms experience large run-ups prior
to the issuance of a sample of 4613 US SEOs over 25 years from 1982
through 2006. Previous studies also compare pre-issuance stock returns
between SEOs and other security issues. Marsh (1982) finds that the
average equity-issuing firm experiences 28 percent market-adjusted
returns over one year preceding the issue, compared to 5 percent for
2
On the other hand, some researchers, such as Brav et al. (2000), Eckbo et al.
(2000), and Butler et al. (2005), challenge the market timing hypothesis. Eckbo,
Masulis, and Norli (2000) attribute the ‘new issues puzzle’ of SEO issuers to a
technical failure to control for risk.
Y. Lan et al.
the average debt issuer. Gomes and Phillips (2012) indicate that public
equity offerings are associated with significantly higher past abnormal
returns than private offerings. Meanwhile, there is mixed evidence on the
relation between pre- and post-announcement returns. Bayless and
Chaplinsky (1996), and Bilinski and Strong (2013) report a negative and
significant relationship between them, while Asquith and Mullins (1986)
and Dissanaike et al. (2014) suggests the price reduction at announce-
ment day tends to be smaller after a large price increase.
Even though the aforementioned findings are generally consistent
with the overvaluation hypothesis, the literature offers alternative ex-
planations for the pre-announcement price run-up and post-
announcement price reduction. Korajczyk et al. (1991, 1992) suggest
that firms tend to issue equity after significant information releases,
which will affect stock returns, to avoid the negative impact of infor-
mation asymmetry on SEO. Lucas and McDonald (1990) developed an
information asymmetry-based model in which undervalued firms post-
pone SEOs until good news on the value of the firm's assets comes to the
market, and stock prices reflect the proper value. This model predicts that
firms experience stock price appreciation before SEO announcements,
but this does not necessarily indicate that SEO firms' shares are over-
valued. Aside from information theory, Korajczyk et al. (1990) suggest
that managers will issue new shares when they access profitable invest-
ment projects, which also boost the firm's stock price.3 Consistent with
the growth opportunity explanation, Kang et al. (1999) document a
non-negative announcement period abnormal return for Japanese equity
offerings.4 Real option theory indicates firms experience stock price
reduction following SEO announcements due to the reduction in the
volatility of the underlying assets of the real option (Carlson et al., 2006).
Besides, Loughran and Ritter (1997) show that issuing firms experi-
ence a dramatic improvement in operating performance preceding the
offering. This fact suggests that firms may announce new share issues
following a strong operating performance, which will increase the firm's
stock price. Competing explanations for the stock price reduction
following SEO announcements include capital structure change (DeAn-
gelo and Masulis, 1980), downward-sloping demand curve (Scholes,
1972), and increased free cash flow problems (Lee, 1997). For instance,
Masulis and Korwar (1986) argue that greater price rises preceding SEO
announcements are associated with greater post-announcement price
drops because the pre-announcement stock price appreciation brings
firms' leverage down and, in turn, decreases the need for further leverage
reduction by the SEO.
These findings suggest that existing evidence does not sufficiently
support the overvaluation hypothesis. Stock prices following a run-up
and then a reversal surrounding SEO announcements could be due to
various confounding reasons. To address the concern, we introduce
investor sentiment as an instrument to distinguish overvaluation from a
high rational valuation. Although traditional finance theory suggests that
irrational investors’ behaviors should be exploited by arbitrageurs, and
stock prices reach their intrinsic value in equilibrium, the behavioral
finance literature has increasingly argued that mispricing systematically
exists in the market. In a seminal paper, DeLong et al. (1990) present a
model suggesting that noise traders can collectively deter rational arbi-
trageurs and drive prices away from fundamental values (i.e., over-
valuation). Barberis et al. (1998) theoretically argue that noise is
systematically related to stock price and causes mispricing. Baker and
Wurgler (2006) find that investor sentiment has predictive power on
future stock returns, especially for firms with particular characteristics
(small, young, high volatility, unprofitable, non-dividend paying,
fast-growing, and distressed stocks). Brown and Cliff (2005) point out
that high sentiment diverts a concurrent stock price upward from its
3
Bo et al. (2011) point out that the principal purpose of SEOs is to finance
new investment and growth opportunities.
4 Exchange (SZSE), announcing SEOs over the period 2006 to 2019. We
Eckbo et al. (2007) note that equity offerings are regarded as positive news
in Japan.
3
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intrinsic value and results in significantly low returns over the next two to
three years. Non-US research also reports that sentiment has a significant
influence on stock returns: Schmeling (2009) for 18 industrialized
countries; Corredor et al. (2013) for four key European markets (France,
Germany, Spain, and the UK); Tsuji (2006) for Japan; Kling and Gao
(2008) for China; Dash and Mahakud (2013) for India. The literature on
corporate security issues also suggests that management tends to offer
new shares to the public when investor sentiment is positive (Baker and
Stein, 2004; Baker and Wurgler, 2000; Bayless and Chaplinsky, 1996;
Cohen et al., 2007).
Shiller (1981) points out that market prices represent the outcome of
the interaction between fundamentals and sentiment. In a similar vein,
Shleifer and Summers (1990) suggest that shifts in investor demand for
securities are attributable to changes in fundamental conditions or
sentiment. Given that previous studies identify investor sentiment as a
factor associated with mispricing, we premise that stock price run-up
preceding SEO announcements represents overvaluation when it is
driven by investor sentiment. The behavioral finance literature generally
labels stock valuation which is not justified by fundamental facts at hand
as investor sentiment (Baker and Wurgler, 2007; Shleifer and Summers,
1990). Although many previous papers find a significantly positive
abnormal return before SEO announcements, it is not appropriate to treat
the whole abnormal return as overvaluation since at least a part of the
abnormal return is attributable to fundamental factors. Given that firms
tend to announce SEOs following the arrival of profitable investment
opportunities and strong operating performance, pre-announcement
abnormal returns potentially capture fundamental factors (Korajczyk
et al., 1990; Loughran and Ritter, 1997). We decompose
pre-announcement abnormal returns into fundamental and
sentiment-driven ones. The overvaluation hypothesis predicts that stock
prices deteriorate more following SEO announcements as the
sentiment-driven pre-announcement return is high. This idea accords
with the analysis by Hertzel and Li (2010). To distinguish the mispricing
theory from the investment theory, Hertzel and Li (2010) decompose
market-to-book ratios into three components: firm-specific error, sector
error, and long-term value to book. Hertzel and Li (2010) show that the
means of all three components of the market-to-book ratio are signifi-
cantly higher for issuing companies than for non-insuring matched ones.
Besides, Hertzel and Li and Zhang (2008) find issuers with high mis-
valuation have more negative post-issue abnormal returns. Differently
from Hertzel and Li (2010), we examine whether the stock price increase
before SEO announcements is due to overvaluation and whether stock
price run-up disappears in the post-announcement period from the
perspective of investor sentiment.
3. Sample selection, data, and methodology
3.1. Sample selection and data
One advantage of Chinese data is the long interval between the initial
SEO announcement and the final execution of the SEO. Mikkelson and
Partch (1986) report that the average interval is 27 days for their US SEO
sample. The short interval affects the examination of stock valuation in
various ways. Firstly, SEOs sends a signal that the current stock price is
overvalued and will decline in subsequent periods. Secondly, SEO
execution generates downward price pressure through the increased
supply of stocks. Thus, the effect of investor sentiment on
post-announcement returns could be contaminated. However, as shown
in Panel A of Table 2, the average (median) interval for Chinese SEOs is
293 (254) days makes post-announcement returns less susceptible to the
execution effects. Therefore, Chinese data are advantageous for exam-
ining the pure effects of SEO announcements.
Our sample selection starts with a collection of SEO data of Chinese
firms listed on the Shanghai Stock Exchange (SSE) or the Shenzhen Stock
choose 2006 as the starting point of event collection since the Chinese
Y. Lan et al.
Table 1
Definition of variables.
Variables Definition
Macro-economic variables
CPI Natural logarithm of monthly Consumer Price Index
ConsGrowth Growth rate of consumer consumption expenditure for the quarter
from the same quarter of the previous year. For the first two months
of the quarter, we adopt the data of the preceding quarter.
IndGrowth Growth rate of industrial production for the month from the same
month of the previous year
PMI Natural logarithm of monthly Manufacturing Purchasing Managers'
Index
Firm-level variables
FirmAge Natural logarithm of the number of years from the foundation of the
firm to the year of SEO announcement
FirmSize Natural logarithm of the book value of assets at the year preceding
SEO announcement
Tobin's Q (Market value of equity þ book value of net liabilities)/(total assets –
intangible assets), computed by using data from the year preceding
SEO announcement
Leverage Book value of total liabilities divided by book value of equity,
computed by using data from the year preceding SEO announcement
ROA Net income divided by book value of assets, computed by using data
from the year preceding SEO announcement
IssueSize Proceeds to be raised/(the number of outstanding A-shares for the
preceding year  the closing stock price for the month preceding the
announcement)
Volatility The firm-specific standard deviation of stock returns adjusted by the
stock return standard deviation of other firms in the same industry in
every year
Liquidity The number of traded shares each month over the total number of
shares outstanding
DAccrual Discretional accruals computed from the Modified Jones model
(Dechow et al., 1995)
SOE Dummy variable that equals one for state-owned enterprises, and
zero otherwise
Investor sentiment variables
MReturn Market index return. We mainly use the arithmetic mean of SSE and
SZSE A-share index returns
FundMReturn The component of MReturn, which can be explained by macro-
economic fundamental conditions
SentiMReturn The error term of the regression of MReturn
CTO The overnight return computed by following the approach of
Aboody et al. (2018)
Government initiated a big reform (Split-Share Structure Reform) in
April 2005, which aims to convert non-tradable shares into tradable
shares. Since non-tradable shares used to account for two-thirds of
domestically listed A-shares, this reform is likely to have changed stock
price movements surrounding SEOs considerably. We limit our attention
to public offerings and initially obtained the SEO data from the China
Stock Market and the Accounting Research (CSMAR) database and the
Wind database. If there is any inconsistency between the two initial data
sources, we hand-collected SEO data from financial reports and offering
prospectuses provided by the China Securities Regulatory Commission
(CSRC). Our SEO data include the initial announcement day of SEO plans,
the execution day, the expected number of newly issued shares, and
proceeds to be raised. We exclude financial firms, utilities, and those
receiving the special treatment (ST) from our sample and require sample
firms to have publicly announced the SEO plan. The financial data of
sample companies are obtained from the CSMAR database. Then, we
match the SEO data with financial data of the preceding year. The pro-
cedure leaves us with 83 SEOs by 74 firms in our sample.
It is noteworthy that the number of SEOs after 2013 is neglectable. We
argue the main reason is that the regulation is unfriendly to the public
offering of seasoned equity (SEO). CSRC requires the pricing of SEOs is
based on the market prices days before final execution. However, as
shown in Panel A of Table 2, it takes an average (median) firm 291 (254)
days to execute an announced SEO plan. Since SEOs are generally
interpreted as a negative signal, the prolonged interval leaves the market
enough time to react and to adjust prices. From the perspective of
regulation, this is beneficial for new investors facing the risk of being
4
Economic Modelling xxx (xxxx) xxx
exploited by the market-timing insiders. On the other side, however, the
pricing regime leads Chinese issuers to lose informational advantages
enjoyed by their American counterparts. Even if they successfully spot a
window of opportunity, the market could have corrected the temporarily
overvalued prices over such a long period of time from announcement to
execution. As a result, those would-be issuers could be crowded out and/
or turn to the private placement market for new equity.
We define our announcement day (day 0) as the day on which the
CSRC platform announces the SEO.5 Following Cohen et al. (2007), we
adopt market returns to construct an investor sentiment variable. Brown
and Cliff (2005) point out that sentiment levels and changes are strongly
correlated with contemporaneous market returns. Loughran and Ritter
(1997) indicate that approximately half of the total return that the
average SEO firm experienced was attributable to market run-ups.
However, it should be noted that strong market returns might simply
represent strong fundamental conditions rather than high investor
sentiment. Shleifer and Summers (1990) suggest that sentiment-driven
demand shifts are attributable to noise traders' over- or under-reactions
to fundamental news. As a result, research on investor sentiment needs
to construct sentiment variables that are not contaminated by funda-
mentals (Baker and Wurgler, 2007). We employ as a proxy for investor
sentiment the error term of time-series regression of market index return
that adopts macro-economic variables as explanatory variables (Baker
and Wurgler, 2007, 2006). The error term represents the component of
market index returns, which is not attributable to fundamental condi-
tions and thus likely represents market-wide investor sentiment at the
month. Using the error term is also consistent with Brown and Cliff's
(2004) explanation that speculators (traders who have a bias in their
asset valuation) expect a return greater or lower than fundamental ex-
pected returns. Specifically, we estimate the following equation by using
monthly data from January 2005 to December 2013. Necessary
macro-economic ratios are available from the Web site of the National
Bureau of Statistics of China.
MReturnt ¼ a þ b1 CPIt þ b2ConsGrowtht þ b3IndGrowtht þ b4PMIt þμt,(1)
MReturnt: Market index return in month t.
CPIt: Consumer price index in month t.
ConsGrowtht: Consumption growth in month t.
IndGrowtht: Industry production growth in month t.
PMIt: Manufacturing purchasing managers index in month t.
We adopt the simple average of SSE and SZSE market index returns as
a measure of MReturn. The expected value of the regression, which is
denoted by fundamental-driven market return (FundMReturn), repre-
sents a component of market return that is attributable to fundamental
conditions. In contrast, the error term of the regression (ut), which is
denoted by sentiment-driven market return (SentiMReturn), represents a
component of market returns that is attributable to investor sentiment.
The definition of other variables is displayed in Table 1.
Baker and Wurgler (2006) employ growth in industrial production,
real growth in consumption, growth in employment, and the NBER
recession indicator in the regression of market index return. We follow
them to adopt the year-on-year quarterly growth rate in consumer con-
sumption expenditure (ConsGrowth), and year-on-year monthly indus-
trial production growth rate (IndGrowth).6 Only quarterly data are
available for ConsGrowth. The value of quarter t
1 is assigned to the
first two months of quarter t, while we adopt the value of quarter t for the
last month of quarter t. Since a recession indicator is not available for
China, we employ the natural logarithm of the manufacturing purchasing
5
Chinese companies publicly announce SEOs after a board meeting by using
the platform provided by the CSRC. We stand on the understanding that in-
vestors access SEO information only on the day of the announcement by CSRC
format. Also, board meeting day is unavailable for many of our events.
6
We do not adopt the growth in employment since Chinese unemployment
data provided by NBSC show almost no variations.
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 2
Descriptive statistics.
Variable Mean Median Min Max Std. N

Panel A: Issuance characteristics

Length Ann.-Issue(Days) 291.40 254.00 87.00 865.00 154.19 83
Planned Proceeds(Millions) 2094.45 1120.00 60.00 16000.00 2724.71 83
Raised Proceeds(Millions) 1914.59 1000.00 0.10 16000.00 2665.99 83
IssueSize 0.45 0.32 0.02 2.40 0.42 83
Panel B: Firm characteristics
FirmSize 22.23 22.03 20.06 25.36 1.38 83
FirmAge 11.88 11.00 4.00 23.00 4.47 83
Leverage 1.59 1.33 0.23 8.40 1.20 83
ROA 0.06 0.06 0.00 0.17 0.03 83
Tobin's Q 1.63 1.30 0.75 5.24 0.84 83
Volatility
0.00
0.00
0.01 0.02 0.01 83
Liquidity 0.01 0.01 0.00 0.04 0.01 83
DAccual 0.01
0.02
0.21 0.39 0.10 83
SOE 0.51 1.00 0.00 1.00 0.50 83
CTO
0.00
0.00
0.04 0.02 0.01 83
Panel C: Investor sentiment variables
MReturn 0.02 0.03
0.24 0.25 0.09 97
FundMReturn 0.01 0.01
0.09 0.09 0.02 97
SentiMReturn 0.00 0.01
0.24 0.21 0.09 97
CTO
0.00
0.00
0.10 0.11 0.01 211,942
Panel D:Investor sentiment for months with and without SEO announcements
Variable NoAnn.-Mean[Median] Ann.-Mean[Median] T-test Z-test
MReturn
0.01[0.01] 0.04[0.05]
2.73***
2.53**
FundMReturn 0.01[0.01] 0.02[0.02]
3.08***
2.62***
SentiMReturn
0.02[-0.03] 0.03[0.03]
2.84***
2.68***
CTO
0.00[-0.00]
0.00[-0.00] 0.50
1.84*

This table shows summary statistics for the main variables. See Table 1 for variable definitions. ***, **, * denote significance at the 1%, 5%, and 10% levels respectively.

Managers' Index (PMI), which is widely thought of as the earliest indi-
cator of the economic condition (Koenig, 2002; Tsuchiya, 2014). Given
that many researchers find a positive (Crosby, 2001; Graham, 1996;
Oxman, 2012) or negative (Bodie, 1976; Gultekin, 1983) relation be-
tween nominal stock returns and inflation rate, we include the natural
logarithm of the Consumer Price Index (CPI) in Model (1). Chinese
monthly industrial production data are missing for January. We substi-
tute the data of the previous month (December in the previous year) for
January's industrial production. We replicate the following analyses by
deleting monthly industrial production data in January and find quali-
tatively the same results. We run the OLS regression of MReturn over the
period from January 2005 to December 2013. Table 2 presents descrip-
tive statistics of the market return variables (MReturn, FundMReturn,
and SentiMReturn), the firm-specific sentiment variable (CTO), and other
firm characteristics. Panel C of Table 2 indicates that the Chinese stock
market generated a two percent monthly return, on average, during our
sample period. SentiMReturn is volatile relative to FundMReturn. Panel
D of Table 2 compares market return variables between months with and
without SEO announcements. All the market return variables have
significantly larger means and medians for months with SEO an-
nouncements than for those without. Consistent with previous findings,
this result suggests firms tend to announce SEOs when the market is in a
favorable condition.
3.2. Abnormal return computation
To determine the impact of investor sentiment, we examine the
abnormal returns during the pre-announcement period as well as the
post-announcement period. We expect stock prices of sample firms to rise
abnormally during the pre-announcement period and decline during the
post-announcement period. As part of the event study, the 200-day
estimation window starts from day
261 to day
61, and the event
window is from day
60 to day 60.7 We use the market model to
determine the abnormal.8
Table 3 reports the mean and median cumulative abnormal returns
(CAR) for our sample events during the period from day
60 to day 60.
The mean daily abnormal return turns to positive around day
35, and
then CAR(-60, t) increases to 5.13 percent at day
1 (CAR(t1, t2) in-
dicates CAR for the period from day t1 to day t2). CAR (
60, t) starts to
decline at day 0, and CAR(0, t) stabilizes at around day 35. Thus, we
employ the period from day
35 to day
1 as the pre-announcement
period, the period from day 0 to day 35 as the post-announcement
period. Consistent with previous studies, SEO firms experienced signifi-
cant stock price increases before the announcement and significant de-
clines in the post-announcement period. Previous US literature mainly
investigates two-day announcement returns (Asquith and Mullins, 1986;
Mikkelson and Partch, 1986). However, short-term CARs do not seem to
fully capture the SEO announcement effect since CARs continue to
decline in the subsequent periods. Therefore, we track stock returns for a
relatively long interval to accurately examine the relation between pre-
and post-announcement returns.
3.3. Control variables
We introduce various firm and issuance characteristics to control for
cross-sectional differences in pre- and post-announcement returns. Issue
size is conventionally used to test the idea that the demand curve for
shares is downward sloping. We use the amount of proceeds scaled by the
market capitalization of outstanding A-shares (IssueSize) to measure
issue size. Large firms tend to suffer less information asymmetry than
small companies do due to more information disclosure and analyst
coverage (Barry and Brown, 1984). We adopt the natural logarithm of
book assets (FimSize) to control for the impact of firm size. Young firms
require substantial capital to finance investment opportunities (Bilinski
and Strong, 2013; DeAngelo et al., 2010). Meanwhile, young firms are
likely to suffer sever information asymmetry (James and Wier, 1990;
Krishnaswami et al., 1999). We adopt the number of years between the

7
For any alternative event windows starting from day
100,
150 or
200,
the estimation window is pushed forward accordingly to assure the estimation
window ends before the event window.
8
The results are qualitatively unchanged when using other advanced pricing
models such as the Liu et al. (2019) model tailored for Chinese firms.

5
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 3 that managers will issue new shares when they get access to profitable
Abnormal returns around SEO announcement. investment projects. We adopt Tobin's Q to test the growth option hy-
Panel A: Abnormal returns pothesis and predict it to be positively related to the pre- and
post-announcement returns. Meanwhile, we should note that high
Day Mean Mean Number CAR(0,t) Number
[Median] [Median] [Ratio] of [Ratio] of Tobin's Q also represents overvaluation (Hertzel and Li, 2010). If the
AR CAR(-60,t) positive positive overvaluation story is the case, Tobin's Q should be positively related to
CAR(-60,t) CAR(0,t) pre-announcement returns but negatively associated with

60 0.22 0.22 44 [49.44] post-announcement returns. SEOs potentially generate overinvestment
[-0.04] [-0.04] problems, which will decrease post-announcement stock returns (Carlson

50
0.16
0.90 47 [52.81] et al., 2006). We use data preceding announcement day for the afore-
[-0.39] [0.43]
mentioned firm-level variables. We also control for the level of liquidity,

40
0.16
0.01 43 [48.31]
[-0.36] [-0.64] volatility, and the nature of ownership (i.e., SOE). Descriptive statistics of

35 0.53
0.96 43 [48.31] the control variables are shown in Table 2.
[-0.21] [-0.84]

30 0.25
0.02 47 [52.81]
4. Empirical results
[-0.05] [1.07]

20
0.17 0.64 [3.19] 51 [57.30]
[-0.13] We first attempt to confirm that a negative relationship exists be-
20
1.11
4.11 39 [43.82]
7.89 26.00 tween pre- and post-announcement abnormal returns in our sample.
[-0.52] [-5.07] [-7.33] [29.21] Table 4 presents the results of regressions of CAR(0, 35) on pre-
30 0.72
5.81 37 [41.57]
9.59 25.00
announcement CARs as the key independent variable. Consistent with
[-0.01] [-5.33] [-8.24] [28.09]
35
0.29
7.45 34 [38.20]
11.23 25.00 Bayless and Chaplinsky (1996), Bilinski and Strong (2013), Masulis and
[-0.81] [-4.32] [-9.66] [28.09] Korwar (1986), results clearly suggest that pre-announcement CARs are
40 0.39
6.72 38 [42.70]
10.50 23.00 negatively and significantly related to post-announcement CAR (CAR(0,
[0.38] [-3.55] [-10.52] [25.84]
35)). Coefficients on CAR(-50,-1) and CAR(-60,-1) are not statistically
50
0.20
7.75 40 [44.94]
11.54 24.00
[-0.21] [-5.44] [-10.31] [26.97]
significant at the conventional level, but the coefficients are negative and
60 0.08
6.54 39 [43.82]
10.32 27.00 consistent. In untabluated results, we get similar associations when using
[-0.22] [-2.61] [-7.38] [30.34] the Liu et al. (2019) model to compute the abnormal returns. The co-
Panel B: Cumulative abnormal returns efficients of pre-announcement CARs are less than one, implying that the
pre-announcement abnormal stock price run-up does not completely
CARs Mean T-test Median Z-test Std.
disappear in the post-announcement period. Holding other variables
CAR(-60,- 3.78 1.01 2.35 1.21 35.25 constant, a 10 percent increase in the pre-announcement CAR(-35,
1) is
1)
CAR(-50,- 4.51 1.49 2.48 1.36 28.64
associated with a 2.16 percent decline in CAR(0, 35). Since the relation
1) between post- and pre-announcement returns stabilizes after day
35,
CAR(-40,- 3.63 1.38 4.16 1.70* 24.8 the following analyses focus on CAR(-35,
1) and CAR(0,35).
1) Although the negative relation between the pre- and post-
CAR(-35,- 5.27 2.10** 4.16 2.59*** 23.73
announcement return supports the overvaluation hypothesis, we
1)
CAR(-30,- 4.05 1.71* 3.46 2.49** 22.31 cannot rule out the possibility that the pre-announcement stock price
1) increase might simply represent improved economic conditions (thereby
CAR(-20,- 2.98 1.59 1.45 2.00** 17.64 increased future cash flow for existing shareholders) and stock prices
1) decline afterward for various reasons such as dilution. Besides, there is no
CAR(0,20)
7.89
4.91***
7.33
4.65*** 15.15
CAR(0,30)
9.59
5.29***
8.24
4.76*** 17.1
strong evidence that the pre-announcement stock price run-up represents
CAR(0,35)
11.23
5.81***
9.66
4.96*** 18.24 overvaluation. To further examine the overvaluation hypothesis, we
CAR(0,40)
10.5
5.09***
10.52
4.72*** 19.47 investigate whether investor sentiment generates an abnormal stock
CAR(0,50)
11.54
4.79***
10.31
4.43*** 22.71 price increase during the pre-announcement period and in turn, produces
CAR(0,60)
10.32
4.00***
7.38
3.70*** 24.33
a sharp stock price decline after the announcement. Specifically, we
This table presents abnormal returns (ARs) surrounding the SEO announcement examine whether the error term of Eq. (1) (SentiMreturn) and firm-
day (day 0). ARs are estimated from the market model using stock prices from specific investor sentiment (CTO) drive pre-announcement returns and
day
260 to day
61. CAR(t1, t2) indicates the cumulative abnormal return whether the sentiment-driven pre-announcement return is negatively
during the period from day t1 to day t2. ***, **, * denote significance at the 1%, associated with the post-announcement return.
5%, and 10% levels respectively.
Table 5 presents results of regressions of the pre-announcement re-
turn (CAR(-35,
1)). FundMreturn, SentiMreturn and CTO take values in
foundation of the firm and SEO announcements as the measure of firm the month before the announcement. In models (1) and (3), the coeffi-
age. The pecking order theory of Myers and Majluf (1984) demonstrates cient on FundMReturn does not have statistical significance. In contrast,
that firms issue debt before going to SEO in the capital market with in- SentiMReturn in models (2) and (3) consistently carries positive and
formation asymmetry. Since the pre-announcement price run-ups have significant coefficients. Regardless of model specifications, the co-
already reduced leverage, subsequent equity issuance will further un- efficients on CTO are always positive and significant, so high investor
dermine the debt tax shield (Asquith and Mullins, 1986; DeAngelo and sentiment drives up pre-announcement return. In Model (4), we directly
Masulis, 1980). We calculate leverage as the ratio of liabilities over book control for macro-economic variables instead of FundMReturn. Consis-
equity and predict it is negatively related to post-announcement returns. tent with the baseline result, the explanation power of investor sentiment
Loughran and Ritter (1997) imply that firms announce SEOs following a variables on pre-announcement CAR is not weakened. Taken together,
robust operating performance, which boosts stock prices. We employ these results in Table 5 serve as direct evidence that the pre-SEO
ROA, computed as net income over book assets, as a proxy for operating announcement stock price run-up is at least partly driven by investor
performance. ROA is predicted to have a positive relation to sentiment. Pre-announcement stock price run-ups are likely caused by
pre-announcement CARs. overvaluation.
Carlson et al. (2006) and Li et al. (2009) point out that firms conduct Next, we examine whether the post-announcement stock price
SEOs to finance growth opportunities. Korajczyk et al. (1990) indicate reduction represents the correction of overvaluation. To address this

6
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 4
Relationship between post-announcement return and pre-announcement return.
Variable (1) (2) (3) (4) (5) (6)

CAR(-20,-1)
0.309**
(-3.76)
CAR(-30,-1)
0.221**
(-3.64)
CAR(-35,-1)
0.216**
(-4.35)
CAR(-40,-1)
0.199*
(-2.91)
CAR(-50,-1)
0.154
(-2.22)
CAR(-60,-1)
0.109
(-2.11)
CTO
1.750
2.167
2.499
2.906
3.125
3.545
(-1.75) (-1.92) (-2.00) (-1.88) (-1.96) (-2.31)
FirmSize
0.040*
0.039**
0.042**
0.039*
0.040*
0.042**
(-2.76) (-3.32) (-3.44) (-3.01) (-3.10) (-4.06)
FirmAge 0.005 0.004 0.004 0.004 0.003 0.004
(1.13) (1.31) (1.24) (1.07) (0.75) (0.82)
Tobin's Q
0.051*
0.054*
0.051*
0.052*
0.045
0.050*
(-2.89) (-2.65) (-2.59) (-2.47) (-2.03) (-2.86)
Leverage
0.030
0.026
0.022
0.023
0.023
0.023
(-1.26) (-1.01) (-0.88) (-0.92) (-0.97) (-1.00)
ROA
0.218 0.001
0.074
0.104
0.257
0.281
(-0.50) (0.00) (-0.18) (-0.27) (-0.69) (-0.66)
IssueSize 0.027 0.038 0.030 0.028 0.029 0.020
(1.15) (1.47) (1.11) (1.06) (1.28) (0.82)
Volatility 2.849 2.646 3.006 2.997 2.979 2.854
(2.04) (1.73) (1.81) (1.88) (1.85) (1.74)
Liquidity 0.537 1.053 1.237 1.412 1.035 0.965
(0.41) (0.83) (1.18) (1.62) (1.29) (1.02)
DAccrual
0.102
0.110
0.139
0.127
0.113
0.079
(-1.15) (-1.31) (-1.85) (-2.12) (-1.32) (-0.77)
SOE 0.030 0.031 0.030 0.028 0.031 0.023
(1.55) (1.16) (1.12) (1.17) (1.21) (1.05)
Constant 0.833* 0.808* 0.859* 0.810* 0.841* 0.878**
(2.53) (2.78) (2.88) (2.54) (2.66) (3.31)

Observations 83 83 83 83 83 83
Adjusted R2 0.100 0.090 0.104 0.102 0.092 0.079

This table presents regression results of the CAR(0, 35). All the other variables are defined in Table 1. Each model includes industry and year fixed effects and T-statistics
(in parentheses) are adjusted for clustering by industry and year. ***, **, * denote significance at the 1%, 5%, and 10% levels respectively.

issue, we extract the misvaluation component from pre-announcement
returns. Specifically, we partition the pre-announcement returns into
fundamental- and sentiment-driven returns (i.e., Fund-CAR and Senti-
CAR) by using Eqs. (2) and (3). When Senti-CAR is positive, it repre-
sents overvaluation, and we predict it to be negatively related to the post-
announcement return.
Fund-CAR(-35,-1)it ¼ FundMReturnFundMReturnt þ XFundXFundit,
Senti-CAR(-35,-1)it ¼ SentiMReturnSentiMReturnt þ CTOCTOit
where represents estimated coefficients from the Model (3) of Table 5;
XFundit represents firm-level fundamental variables (i.e., variables in the
Model (3) of Table 5 excluding SentiMReturn and CTO). In the following
regressions, we employ Senti-CAR as the main independent variable.
SentiMReturn and Senti-CAR are materially the same, but Senti-CAR is
more direct in capturing the relation between pre-announcement price
run-up and the post-announcement reversal. In addition to misvaluation
associated with market-wide sentiment (i.e., SentiMReturn), Senti-CAR
also reflects the impact of firm-specific sentiment (i.e., CTO). Thus,
Senti-CAR is more advantageous to investigate how investor sentiment
drives the stock price movement surrounding SEO announcements.
Results of post-announcement return (CAR(0, 35)) are presented in
Table 6. We first conduct a benchmark estimation, which does not
include pre-announcement return variables. Model (1) yields a signifi-
cant coefficient on CTO, and a one percent increase could bring
CAR(0,35) down by more than five percent. When including Fund-CAR(-
35,-1) and Senti-CAR(-35,
1) separately in Model (2) and Model (3),
both of them carry a negative and significant coefficient. We get similar
results when using FundMReturn and SentiMReturn directly in Model (5)
and Model (6). When we replicate the analysis by simultaneously
including Seni-CAR (
35,
1) and Fund-CAR(-35,
1) (Model (4)), the
post-announcement return is still negatively related to Senti-CAR(-35,

1). Regardless of model specification, the coefficient on Fund-CAR(-
35,
1) is significantly positive, suggesting the market react positively
(2) to SEOs with a robust fundamental.
(3)
5. Additional analyses
5.1. Alternative post-announcement CARs
The baseline analyses adopt CAR(0, 35) and CAR(-35,
1) to capture
the post- and pre-announcement return, respectively. As a robustness
check, we replicate the analysis by using CARs over various windows and
summarize the results in Table 7. As indicated by Panel A of Table 7,
regardless of event windows, investor sentiment variables SentiMReturn
and CTO are positively and significantly related to pre-announcement
abnormal returns, while the coefficients on FundMReturn are not
consistently significant. Panel B of Table 7 summarizes the regression
results of various post-announcement CARs on various decomposed pre-
announcement CARs. It suggests that Fund-CARs consistently carry
significantly positive coefficients while most coefficients on Senti-CARs
are negative and significant. Notably, sentiment-driven CARs only
carry significant coefficients in the regressions of post-announcement
return over a period shorter than 50 days, while most of the pre-

7
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 5 Consumer Confidence (provided by the Conference Board). We construct

Relationship between pre-announcement return and investor sentiment. another sentiment (fundamental)variable SentiPC2(FundPC2) by adding
Variable (1) (2) (3) (4) the corresponding survey data from the CSMAR into the principal
component analysis. Then, we regress CAR(-35,
1) against these
FundMReturn
0.909
1.697
(-0.78) (-1.51) sentiment and fundamental variables as well as firm characteristic vari-
SentiMReturn 0.580* 0.682** 0.769*** ables to construct sentiment- and fundamental-driven pre-announcement
(2.51) (4.60) (22.61) returns.
CTO 14.217*** 12.881*** 13.356*** 13.093*** Panel A of Table 8 summarizes the coefficients of the new funda-
(8.72) (7.34) (6.81) (9.84)
CPI
3.475
mental/sentiment variables in regressions of pre-announcement CAR(-
(-0.54) 35,
1); Model (1) is different from Model (2) in that the former adopts
ConsGrowth 1.582 FundPC1 and SentiPC1, while the latter uses FundPC2 and SentiPC2.
(1.86) Both include the firm-specific sentiment variable as an explanatory var-
IndGrowth 0.195
iable. The results suggest that coefficients on the new sentiment variables
(0.46)
PMI
1.664* are only marginally significant, while CTO is significantly related to pre-
(-2.61) announcement returns at the conventional level. As with previous ana-
FirmSize
0.028
0.026
0.024
0.033 lyses, Panel B of Table 8 decomposes pre-announcement returns and
(-1.03) (-0.86) (-0.87) (-1.56) regresses post-announcement returns against the decomposed pre-
FirmAge 0.005 0.004 0.006 0.005*
(1.92) (1.07) (1.93) (2.39)
announcement returns. Not surprisingly, all the sentiment-driven pre-
Tobin's Q 0.015 0.006 0.007 0.006 announcement returns are negatively and significantly associated with
(0.41) (0.17) (0.19) (0.28) the post-announcement returns. Taken together, the evidence indicates
Leverage 0.015 0.015 0.021 0.030 that our main findings are robust to the measurement of investor
(0.33) (0.29) (0.42) (0.72)
sentiment.
ROA 1.321 0.932 1.227 1.561
(1.98) (1.63) (1.89) (1.17) Since there are two stock exchanges in China (SSE and SZSE), we have
Volatility 4.317** 3.974* 4.445* 4.528 so far adopted the average returns of these two markets as a proxy for
(3.35) (2.74) (2.95) (2.04) market index return. As a further test, we adopt index return of the
Liquidity 0.440 0.232 0.244 1.001 market on which the firm is not listed to construct the fundamental and
(0.94) (1.38) (0.59) (0.79)
sentiment variables (SSE index return for firms listed on SZSE, and vice
DAccrual
0.747**
0.661
0.619*
0.602**
(-3.28) (-2.34) (-2.51) (-3.88) versa). Chinese firms can choose either of the exchanges for listing. The
SOE 0.051 0.042 0.048* 0.042* index return for the firm's listing market should incorporate the funda-
(2.09) (1.87) (2.44) (2.67) mental conditions of the firm. Put it differently, we can isolate the SEO
Constant 0.511 0.469 0.424 22.966
firm's fundamental conditions from market return by using the index
(1.04) (0.88) (0.84) (0.84)
return for the non-listing market. Specifically, we estimate Eq. (1)
Observations 83 83 83 79 separately for the SSE and SZSE index returns to estimate sentiment- and
Adjusted R2 0.318 0.347 0.350 0.348
fundamental-driven market returns, and then use the fundamental- and
This table shows the regression results of CAR(-35,
1). All the other variables sentiment-driven returns for the non-listing market (FundOMReturn and
are defined in Table 1. Each model includes industry and year fixed effects and T- SentiOMReturn) in the regression of pre-announcement return.
statistics (in parentheses) are adjusted for clustering by industry and year. ***, In Table 9, we first estimate the sentiment-driven CAR (i.e.,
**, * denote significance at the 1%, 5%, and 10% levels respectively. SentiOMR-CAR(-35,-1)), bySentiOMReturn, and then regress CAR(0, 35)
against it while controlling for other firm and issuance characteristics.
announcement abnormal returns being corrected over a period of 20 We find that CAR(0, 35) is negatively related to SentiOMR-CAR(-35,-1)
days. These results suggest the overvaluation hypothesis holds in the and positively to FundOMR-CAR(-35,-1). In unreported results, we find
short period of time around SEO announcements. that both SentiOMReturn and FundOMReturn are positively associated
with CAR(-35,
1). In summary, we present supporting evidence for the
5.2. Using other sentiment variables overvaluation hypothesis and the evidence is robust to the choice of
investor sentiment variables.
We have employed the market return to construct a market-wide
investor sentiment variable. In addition to market return, the literature
on behavioral finance uses market turnover and new issue volume to 5.3. Long-term pre-announcement return
construct investor sentiment variables. Bayless and Chaplinsky (1996)
use the aggregate volume of equity issues, and Baker and Wurgler (2006) While the stock prices of our event companies show a sharp run-up
adopt the share of equity issues in total equity and debt issues as a proxy from around day
60, the increasing trend starts approximately 200
for investor sentiment. Baker and Stein (2004) point out that market days before announcement day. Further, we examine the relationship
liquidity measures, such as turnover represent investor sentiment. As a between the long-term pre-announcement return and the post-
robustness check, we add these alternative sentiment variables to announcement return. This analysis computes abnormal returns as raw
construct an investor sentiment variable. Specifically, we estimate Eq. (1) returns less the market return. Consistent with previous findings, Panel A
by using the market turnover (or new equity issues scaled by the sum of of Table 10 shows a significantly negative relation between the post-
new issues of equity and debt) as a dependent variable. Then, we make announcement return and long-term abnormal pre-announcement
fundamental-driven turnover (new stock issues) and sentiment-driven returns over a period of up to 200 days. Importantly, Panel B of
turnover (new stock issues). We conduct principle component analysis Table 10 shows that market-wide investor sentiment, proxied by Sen-
and synthesize the sentiment-driven market return, turnover, and new tiMReturn, is significantly associated with CAR(-60,
1) and firm-
stock issues into a single sentiment variable (SentiPC1). We also specific sentiment proxy CTO is related with pre-announcement returns
construct a fundamental variable (FundPC1) by implementing principle over a longer period (CAR(-100,
1), CAR(-150,
1) and CAR(-200,
component analysis for fundamental-driven market index returns, turn-
1)). In line with the baseline results, sentiment-driven pre-announce-
over, and new stock issues. Previous studies also adopt sentiment indices ment returns over the long term are significantly related to CAR(0, 35).
constructed by surveys such as the Michigan Consumer Sentiment Index Therefore, our main findings are robust to the choice of the pre-
(provided by Thomson Reuters/University of Michigan) and the Index of announcement period.

8
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 6
Regressions of post-announcement return on decomposed pre-announcement return.
Variable (1) (2) (3) (4) (5) (6) (7)

Fund-CAR(-35,-1) 1.485*** 1.254**

(7.95) (4.76)
Senti-CAR(-35,-1)
0.681**
0.483**
(-3.38) (-3.97)
FundMReturn
2.520***
2.128***
(-6.42) (-6.34)
SentiMReturn
0.464*
0.330
(-2.38) (-2.05)
CTO
5.512**
4.575* 4.430 2.335
4.575*
4.661**
4.116
(-3.95) (-2.64) (2.05) (1.21) (-2.64) (-3.20) (-2.28)
FirmSize
0.036* 0.002
0.037*
0.005
0.035*
0.037
0.036*
(-2.67) (0.15) (-2.70) (-0.42) (-2.47) (-2.28) (-2.42)
FirmAge 0.003
0.003 0.003
0.002 0.005 0.003 0.005
(0.54) (-0.47) (0.34) (-0.26) (0.83) (0.41) (0.57)
Tobin's Q
0.056
0.064**
0.045
0.055*
0.054*
0.045
0.046
(-2.09) (-3.25) (-1.76) (-2.84) (-2.61) (-1.68) (-1.98)
Leverage
0.025
0.049*
0.026
0.045
0.018
0.026
0.020
(-1.18) (-2.41) (-1.19) (-2.07) (-0.98) (-1.20) (-1.02)
ROA
0.325
1.660**
0.142
1.323* 0.163
0.142 0.216
(-0.64) (-3.62) (-0.28) (-2.68) (0.30) (-0.27) (0.41)
IssueSize 0.026 0.020 0.040 0.031 0.020 0.040* 0.031
(1.96) (0.95) (1.67) (1.69) (1.14) (2.41) (1.72)
Volatility 2.141
3.724** 2.170
2.791 2.878* 2.170 2.783*
(1.31) (-4.20) (1.30) (-1.98) (2.63) (1.31) (2.46)
Liquidity 1.137 0.825 1.320 1.003 1.187 1.320 1.309
(0.80) (0.68) (1.01) (0.77) (1.09) (1.20) (1.36)
DAccrual 0.029 0.990**
0.063 0.775** 0.071
0.063
0.001
(0.23) (4.36) (-0.39) (3.48) (0.40) (-0.34) (-0.00)
SOE 0.019
0.042 0.024
0.029 0.029 0.024 0.031
(0.44) (-1.54) (0.69) (-0.93) (1.33) (0.74) (1.57)
Constant 0.755* 0.089 0.768* 0.202 0.719 0.768 0.734
(2.51) (0.37) (2.60) (0.74) (2.32) (2.07) (2.25)

Observations 83 83 83 83 83 83 83
Adjusted R2 0.049 0.105 0.078 0.111 0.105 0.078 0.111

This table shows the regression results of CAR(0, 35). Fund-CAR (Senti-CAR) is the component of CAR explained by the fundamental (sentiment) variables in the Model
(3) of Table 5. All the other variables are defined in Table 1. Each model includes industry and year fixed effects and T-statistics (in parentheses) are adjusted for
clustering by industry and year. ***, **, * denote significance at the 1%, 5%, and 10% levels respectively.

6. Conclusion price run-ups mostly disappear in the short-term post-announcement

Information asymmetry theory suggests that managers announce
SEOs when a firm's shares are overpriced, and thus SEO announcements
trigger a price reduction. Indeed, previous empirical studies find a sig-
nificant stock price increase preceding SEO announcements and a sig-
nificant reduction after the announcement (Bayless and Chaplinsky,
1996; Masulis and Korwar, 1986). However, there are alternative ex-
planations for this pattern, and previous studies find mixed evidence
regarding the relation between pre- and post-announcement returns. It is
still unclear whether the stock price movements surrounding SEO an-
nouncements are driven by investor sentiment and how efficiently is the
sentiment-driven misvaluation being corrected by the market. We
address these issues by introducing insights from behavioral finance
literature. We premise that the pre-announcement stock appreciation is
associated with overvaluation to the degree that it is attributable to
investor sentiment. We employ the error term of a time-series regression
of market index return as the main proxy for market-wide investor
sentiment and overnight returns as the proxy for firm-specific investor
sentiment.
We find that pre-announcement abnormal returns have a positive and
significant relation to investor sentiment, while fundamental conditions
and firm characteristics do not have significant explanatory power for the
pre-announcement return. These results suggest pre-announcement stock
price run-ups refect sentiment-driven overvaluation. In addition, post-
announcement returns are negatively related to the component of pre-
announcement abnormal returns, which is attributable to investor
sentiment. Estimated results also suggest that the sentiment-driven stock
period. These results suggest that stock prices decline after SEO an-
nouncements to correct the sentiment-driven pre-announcement over-
valuation. In light of the fact that the SEO market dried and equity issuing
firms turned to other markets after 2013, we argue that the market's
relative efficiency in correcting misvaluation puts the timing-seeking
issuers at a disadvantageous position. Since SEO announcements are
generally interpreted as a signal of overvaluation, it is especially difficult
for market timers to spot another window of opportunity after an SEO
announcement to issue shares at an overvalued price (Huang et al.,
2016).
This paper makes an important contribution to the literature. Firstly,
we attempt to examine the effects of overvaluation in SEOs by intro-
ducing insights from behavioral finance. This paper shows direct evi-
dence that investor sentiment boosts stock prices before SEO
announcements, and the stock price reduction following SEO an-
nouncements is attributable to the modification of sentiment-driven price
run-ups. It would also be noteworthy that we present empirical evidence
of SEO's announcement effects in a market where post-announcement
stock returns are less likely to be contaminated by actual SEO execu-
tions. Secondly, our findings have important policy implications. On the
one hand, even though emerging markets are thought to be less efficient
in correcting, the adverse effect of misvaluation on investors could be
controlled to some extent by appropriate policy design. On the other
hand, policies that emphasize misvaluation alleviation could have un-
intended effects on market sustainability, and a certain level of mis-
valuation may be helpful for the sustainable development of immature
capital markets.

9
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 7
Relationship between investor sentiment and short-term stock returns.
Panel A: Regressions of pre-announcement CARs

Variable CAR(-20,-1) CAR(-30,-1) CAR(-40,-1) CAR(-50,-1) CAR(-60,-1)

FundMReturn
0.986
1.773
1.032
0.963 0.015

(-1.14) (-1.55) (-0.78) (-0.49)
0.01
SentiMReturn 0.583*** 0.454*** 0.654** 0.927*** 1.265**

6.1
6.47
5.35
6.59
4.54
CTO 11.560*** 14.826*** 12.359*** 14.213*** 16.077***

11.68
6.71
8.53
9.23
6.49
Controls Yes Yes Yes Yes Yes

Panel B: Regressions of post-announcement CARs on the pair-wise decomposed pre-announcement CARs

Variable CAR(0,20) CAR(0,30) CAR(0,40) CAR(0,50) CAR(0,60)

Fund-CAR(-20,-1) 1.863** 1.435** 1.948*** 2.264*** 2.368**

(3.57) (5.75) (11.12) (5.90) (3.76)
Senti-CAR(-20,-1)
1.042***
1.020***
0.653***
0.351*
0.158
(-8.65) (-8.14) (-8.01) (-2.57) (-0.69)
Fund-CAR(-30,-1) 1.036* 0.798** 1.083*** 1.259** 1.317**
(2.77) (4.07) (7.17) (5.80) (3.73)
Senti-CAR(-30,-1)
1.340***
1.311***
0.839***
0.451**
0.204
(-15.65) (-11.73) (-10.54) (-4.25) (-1.01)
Fund-CAR(-40,-1) 1.779** 1.370** 1.860*** 2.162*** 2.261**
(3.65) (4.23) (9.18) (8.78) (3.92)
Senti-CAR(-40,-1)
0.930***
0.910***
0.582***
0.313*
0.141
(-9.46) (-8.70) (-7.93) (-2.83) (-0.74)
Fund-CAR(-50,-1) 1.907** 1.469** 1.994*** 2.318*** 2.424**
(3.96) (4.73) (15.83) (6.40) (4.48)
Senti-CAR(-50,-1)
0.656***
0.642***
0.411***
0.221*
0.100
(-7.00) (-7.56) (-7.26) (-2.46) (-0.63)
Fund-CAR(-60,-1)
124.836**
96.172***
130.527***
151.704***
158.675**
(-5.57) (-205.78) (-304.23) (-420.34) (-4.68)
Senti-CAR(-60,-1)
0.481**
0.471**
0.301***
0.162**
0.073
(-4.50) (-4.88) (-6.98) (-3.94) (-0.82)
Controls Yes Yes Yes Yes Yes

This table summarizes the regression results of various windows CARs. Panel A indicates coefficients on FundMReturn and SentiMReturn in the regression of pre-
announcement return. Panel B presents coefficients on Fund-CAR and Senti-CAR. Firm and issuance characteristics are controlled. Each model includes industry and
year fixed effects and T-statistics (in parentheses) are adjusted for clustering by industry and year. ***, **, * denote significance at the 1%, 5%, and 10% levels
respectively.

Table 8
Regressions of post-announcement return: Decomposed by the sentiment variable constructed from the PCA.
Panel A: Coefficients on sentiment variables constructed from the PCA in regressions of CAR(-35, -1)

Variable (1) (2)

FundPC1 SentiPC1 CTO FundPC2 SentiPC2 CTO

Coefficient (T-statistic) 0.059 0.044 13.870*** 0.046 0.054* 13.972***

(1.96) (2.05) (8.60) (1.74) (2.43) (8.89)

Panel B: Regression of post-announcement return CAR(0, 35)

Variable FundPC1-/SentiPC1 FundPC2-/SentiPC2

(1) (2) (3) (4) (5) (6)

FundPC1-CAR(-35,-1)
0.596
0.602

(-1.18) (-1.19)
SentiPC1-CAR(-35,-1)
0.193**
0.194**
(-5.64) (-5.08)
FundPC2-CAR(-35,-1)
0.488
0.516
(-1.06) (-1.04)
SentiPC2-CAR(-35,-1)
0.199**
0.203**
(-5.74) (-5.36)
CTO
5.617**
2.786**
2.875**
5.616**
2.694**
2.752**
(-3.53) (-3.81) (-3.46) (-3.75) (-3.60) (-3.63)
Controls Yes Yes Yes Yes Yes Yes

Observations 83 83 83 83 83 83
Adjusted R2 0.063 0.087 0.103 0.051 0.091 0.096

This table summarizes regression results when using fundamental/sentiment variables constructed by principal component analysis. Panel A reports coefficients of
fundamental and sentiment variables in the regression of pre-announcement return (CAR(-35,
1)). Panel B presents the results of regressions of CAR(0, 35). FundPC1
(SentiPC1) is the principal component extracted from fundamental (sentiment)-driven market return, turnover, and new equity issues. FundPC2 (SentiPC2) is the
principal component extracted from CCI and fundamental (sentiment)-driven market return, turnover, and new equity issues. All the other variables are defined in Table
1. Each model includes industry and year fixed effects and T-statistics (in parentheses) are adjusted for clustering by industry and year. ***, **, * denote significance at
the 1%, 5%, and 10% levels respectively.

10
Y. Lan et al. Economic Modelling xxx (xxxx) xxx

Table 9
Regressions of post-announcement return: Decomposed by the sentiment variable constructed from the other market return.
Variable (1) (2) (3) (4) (5) (6)

FundOMR-CAR(-35,-1) 1.886*** 1.808***

(8.77) (7.57)
SentiOMR-CAR(-35,-1)
0.242**
0.234**
(-4.98) (-4.96)
FundOMReturn
2.520***
2.379***
(-6.42) (-7.34)
SentiOMReturn
0.253
0.141
(-1.37) (-0.81)
CTO
4.575*
2.017
1.234
4.575*
5.072**
4.381*
(-2.63) (-2.01) (-0.94) (-2.64) (-3.36) (-2.36)
Controls Yes Yes Yes Yes Yes Yes

Observations 83 83 83 83 83 83
Adjusted R2 0.105 0.122 0.174 0.105 0.048 0.094

This table shows the regression results of CAR(0, 35). We adopt SZSE (SSE) market return as market index return for SSE- (SZSE) listed companies. FundOMReturn
(SentiOMReturn) is the fundamental (sentiment) component of the market return estimated from the regression of market index return. FundOMR-CAR (SentiOMR-
CAR) is the component of CAR(-35,
1) explained by FundOMReturn (SentiOMReturn). All the other variables are defined in Table 1. Each model includes industry and
year fixed effects and T-statistics (in parentheses) are adjusted for clustering by industry and year. ***, **, * denote significance at the 1%, 5%, and 10% levels
respectively.

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