Long‐Run Performance following Private Placements of Equity

Abstract

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.

Specification analysis of corporate equity financing decision: a conditional residual approach

“…However, Boehmer and Netter (1997) use insider trading as a proxy for insiders' personal belief about their firms' prospects; abnormal insider purchases prior to private placements may reflect insider overoptimism about the future prospects of the firm. This interpretation is consistent with the documented negative long-term post placement stock price performance (Krishnamurthy et al 2005;Hertzel et al 2002) and it is also consistent with the explanation in Hertzel et al (2002) that high levels of capital expenditures around private placement reflects managerial overoptimism. However, we think insider trading being a good proxy for the insiders' private information.…”

“…This article uses seven variables to capture pre-issue ownership structure and the extent of CEOs organization power: (5) the log of the years in CEO position (CEO_tenure) (Berger et al 1997), (6) the number of unaffiliated owners holding at least 5% of shares in the year prior to the equity-offerings (Block), and (7) the ownership by unaffiliated owners holding at least 5% of shares in the year prior to the equity-offerings (Block_share). Ritter (1995, 1997) and Hertzel et al (2002) document that public offering firms have inordinately high pre-issue operating performances but private placement firms have inordinately low pre-issue operating performances. Rozeff and Zaman (1998) suggest that insider purchases (sales) are positively (negatively) related to book-tomarket ratio.…”

“…We therefore restrict our attention to the impact of the omitted new blockholders variable under the monitoring hypothesis. Hertzel et al (2002) document that operating performance remains weak 3 years after the private equity-offerings. It is difficult to figure out the omitted monitoring effect could seriously upward bias the estimated coefficient of abnormal insider purchases (sales).…”

“…However, we think insider trading being a good proxy for the insiders' private information. First, Hertzel et al (2002) fail to explain why the optimism of insiders of private placement firms is higher relative to that of insiders of public offering firms. Second, even when we accept that the optimism of insiders of private placement firms is higher relative to that of insiders of public offering firms, the existing literature fails to explain why the sophisticated (accredited) investors are willing to invest in private placements.…”

Long-run performance following quality management certification

“…For the WLS model these figures are -22.19 and -14.95%, respectively. In a economic sense, this abnormal performance appears to be negatively large, but they are comparable to the Hertzel et al (2002) implied 3-year abnormal returns of -34.82 (equally weighted) and -35.85% (valued weighted) following Equity Private Placements.…”