Despite selling at substantial discounts, private placements of equity are associated with positive abnormal returns. We find evidence that discounts reflect information costs borne by private investors and abnormal returns reflect favorable information about firm value. Results are consistent with the role of private placements as a solution to the Myers and Majluf underinvestment problem and with the use of private placements to signal undervaluation. We also find some evidence of anticipated monitoring benefits from private sales of equity. For the smaller firms that comprise our sample, information eflects appear to be relatively more important than ownership effects.EQUITY PRIVATE PLACEMENT IS among the least-studied methods of corporate capital raising. The few studies that have been published raise provocative questions. An early study by the SEC (1971) reports average discounts of about 30 percent for private placements of unregistered shares. A few small scale studies in the tax-accounting literature find discounts on unregistered shares can exceed 50 percent (Arneson (1981a, 1981b), Friedlob (1983), and Johnson and Racette (1981). In more recent studies, Wruck (1989) reports smaller but still substantial average discounts and Silber (1991) reports discounts on restricted stock averaging 34 percent. Although the illiquidity associated with unregistered stock provides a partial explanation, it is not clear why investors require, and firms are willing to accept, such sizeable discounts. Nor is it clear why registered shares often are privately placed at substantial discounts. The stock price reaction to private placement announcements is also puzzling. Wruck, for example, finds positive announcement period abnormal returns averaging 4.4 percent.^ The positive reaction contrasts with the negative market reaction to public equity issue announce-

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Public firms that place equity privately experience positive announcements effects, with negative post-announcement stock-price performance. This finding is inconsistent with the underreaction hypothesis. Instead, it suggests that investors are overoptimistic about the prospects of firms issuing equity, regardless of the method of issuance. Further, in contrast to public offerings, private issues follow periods of relatively poor operating performance. Thus, investor overoptimism at the time of private issues is not due to the behavioral tendency to overweight recent experience at the expense of long-term averages.

Despite selling at substantial discounts, private placements of equity are associated with positive abnormal returns. We find evidence that discounts reflect information costs borne by private investors and abnormal returns reflect favorable information about firm value. Results are consistent with the role of private placements as a solution to the Myers and Majluf underinvestment problem and with the use of private placements to signal undervaluation. We also find some evidence of anticipated monitoring benefits from private sales of equity. For the smaller firms that comprise our sample, information eflects appear to be relatively more important than ownership effects.EQUITY PRIVATE PLACEMENT IS among the least-studied methods of corporate capital raising. The few studies that have been published raise provocative questions. An early study by the SEC (1971) reports average discounts of about 30 percent for private placements of unregistered shares. A few small scale studies in the tax-accounting literature find discounts on unregistered shares can exceed 50 percent (Arneson (1981a, 1981b), Friedlob (1983), and Johnson and Racette (1981). In more recent studies, Wruck (1989) reports smaller but still substantial average discounts and Silber (1991) reports discounts on restricted stock averaging 34 percent. Although the illiquidity associated with unregistered stock provides a partial explanation, it is not clear why investors require, and firms are willing to accept, such sizeable discounts. Nor is it clear why registered shares often are privately placed at substantial discounts. The stock price reaction to private placement announcements is also puzzling. Wruck, for example, finds positive announcement period abnormal returns averaging 4.4 percent.^ The positive reaction contrasts with the negative market reaction to public equity issue announce-

No abstract