Market Discounts and Shareholder Gains for Placing Equity Privately

Abstract

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-

Earnings management and long-run stock performance following private equity placements

“…Earlier, Hertzel and Smith (1993) and Wruck (1989) demonstrate a positive announcement effect that is opposite of the negative announcement effect shown for public equity offerings. Similarly, Goh et al (1999) show upward earnings forecast revisions for private placements that are opposite to those for public equity offerings.…”

“…In the information-signaling model presented by Hertzel and Smith (1993), a signal of undervaluation is conveyed by the purchase and commitment by private placement investors together with the managerial choice of issuing equity privately. If private placement of equity reflects managerial choice of issuing equity rather than forgoing a profitable investment, it rules out the possibility that managers take advantage of investor optimism at the time of the issue.…”

“…Therefore, a managerial attempt to mislead the sophisticated investors participating in the private placement through earnings management is unlikely in the Hertzel and Smith (1993) information signaling model. Wruck (1989) argues that more concentrated ownership resulting from private placements of equity would lead to monitoring and incentive alignment effects due to the involvement of private placement investors, who are expected to provide monitoring and expert advice in exchange for substantial discounts from current market value.…”

“…The average private discounts reported byHertzel and Smith (1993) andHertzel et al (2002) are 20.1% and 16.5%, respectively. This compares to 3.0% for SEO discounts reported inMola and Loughran (2004).…”

Do Executives' Backgrounds Matter to IPO Investors? Evidence from the Life Science Industry

“…The number of employees is downloaded from SDC. Firm size is used to proxy for information asymmetry because in prior research, many researchers suggest that information asymmetry is likely to be more severe for small firms [63], [64]. Pagano, Panetta and Zingales [64] also discuss about how firm size might be related to information asymmetry.…”