at a lower price.Because the underwriter cannot directly gain from any price appreciation above the offer price on unsold securities,while bearing the full downside of any price fall,there is every incentive to fully distribute the securities offered. Based on the logic of the efficient markets hypothesis,beginning in 1982 the SEC began permitting publicly traded firms meeting certain requirements(basically,large firms)to issue securities without distributing a prospectus.Instead,SEC Rule 415 states that by filing a letter with the SEC disclosing the intention of selling additional securities within the next two years,a firm can sell the securities whenever it wants.Existing disclosures,such as quarterly financial statements,are deemed to be sufficient information to investors.The securities can be taken off the shelf and sold,in what are known as"shelf'issues.In practice,shelf issues are commonly done for bond offerings.Before selling equity,however,many firms prefer to hire an investment banker and conduct a marketing campaign (the road show),complete with a prospectus.From 1984-1992 there were virtually no shelf equity offerings,but they have enjoyed a resurgence since then (Heron and Lie(2003)). 1.3 The information conveyed by investment and financing activities Smith's classic 1986 survey article "Investment Banking and the Capital Acquisition Process,"focused on announcement effects associated with securities offerings and other corporate actions.These transactions can be categorized on the basis of the leverage change and the implied cash flow change.For example,calling a convertible bond (forcing conversion into equity)decreases a firm's leverage and reduces its need for cash flow to meet interest payments, and repurchasing stock increases leverage and uses cash flow.The studies that he surveyed found that leverage-decreasing transactions on average are associated with negative announcement effects if new capital is raised(such as with equity issues).Leverage-increasing transactions on average are associated with positive announcement effects if no new capital is raised (such as with a share repurchase).As Smith pointed out,these patterns are difficult to reconcile with traditional tradeoff models of optimal capital structure.The patterns are consistent,however,with informational asymmetries and agency problems being of importance. There are several problems with interpreting announcement effects.First,and most mechanically,in an efficient market the announcement effect will measure the difference between the post-announcement valuation and what was expected beforehand.If investors had a high likelihood of an announcement occurring beforehand,this updating element is small,and the announcement effect vastly underestimates the impact of the event.Second,any financing activity implicitly is associated with an investment activity,and any investment activity is implicitly associated with a financing activity.Corporate financing and investment actions invariably convey information about both of these activities,due to the identity that sources of funds uses of funds.For example,if a firm raises external capital,the firm is implicitly conveying the information that internal funds will be insufficient to finance its activities(bad news).It is also conveying the information that it will be investing more than if it didn't finance externally.This may be good or bad news,depending upon the desirability of the investment.So the announcement effect depends upon the relative magnitude of multiple implicit and explicit pieces of information. 66 at a lower price. Because the underwriter cannot directly gain from any price appreciation above the offer price on unsold securities, while bearing the full downside of any price fall, there is every incentive to fully distribute the securities offered. Based on the logic of the efficient markets hypothesis, beginning in 1982 the SEC began permitting publicly traded firms meeting certain requirements (basically, large firms) to issue securities without distributing a prospectus. Instead, SEC Rule 415 states that by filing a letter with the SEC disclosing the intention of selling additional securities within the next two years, a firm can sell the securities whenever it wants. Existing disclosures, such as quarterly financial statements, are deemed to be sufficient information to investors. The securities can be taken off the shelf and sold, in what are known as “shelf” issues. In practice, shelf issues are commonly done for bond offerings. Before selling equity, however, many firms prefer to hire an investment banker and conduct a marketing campaign (the road show), complete with a prospectus. From 1984-1992 there were virtually no shelf equity offerings, but they have enjoyed a resurgence since then (Heron and Lie (2003)). 1.3 The information conveyed by investment and financing activities Smith’s classic 1986 survey article “Investment Banking and the Capital Acquisition Process,” focused on announcement effects associated with securities offerings and other corporate actions. These transactions can be categorized on the basis of the leverage change and the implied cash flow change. For example, calling a convertible bond (forcing conversion into equity) decreases a firm’s leverage and reduces its need for cash flow to meet interest payments, and repurchasing stock increases leverage and uses cash flow. The studies that he surveyed found that leverage-decreasing transactions on average are associated with negative announcement effects if new capital is raised (such as with equity issues). Leverage-increasing transactions on average are associated with positive announcement effects if no new capital is raised (such as with a share repurchase). As Smith pointed out, these patterns are difficult to reconcile with traditional tradeoff models of optimal capital structure. The patterns are consistent, however, with informational asymmetries and agency problems being of importance. There are several problems with interpreting announcement effects. First, and most mechanically, in an efficient market the announcement effect will measure the difference between the post-announcement valuation and what was expected beforehand. If investors had a high likelihood of an announcement occurring beforehand, this updating element is small, and the announcement effect vastly underestimates the impact of the event. Second, any financing activity implicitly is associated with an investment activity, and any investment activity is implicitly associated with a financing activity. Corporate financing and investment actions invariably convey information about both of these activities, due to the identity that sources of funds = uses of funds. For example, if a firm raises external capital, the firm is implicitly conveying the information that internal funds will be insufficient to finance its activities (bad news). It is also conveying the information that it will be investing more than if it didn’t finance externally. This may be good or bad news, depending upon the desirability of the investment. So the announcement effect depends upon the relative magnitude of multiple implicit and explicit pieces of information