The Wealth Effects of Reducing Private Placement Resale Restrictions

Abstract

Recently, the US Securities and Exchange Commission reduced resale restrictions on Rule 144 private placements from 12 months to 6 months with the intention of lowering the cost of equity capital for issuing firms. In Canada, similar regulatory changes were adopted several years ago, providing a unique opportunity to test the wealth effects of reducing private placement resale restrictions. We find that shortening resale restrictions reduces the liquidity portion of offer price discounts, and thus lowers the cost of equity capital for issuing firms, but has no significant effect on announcement-period abnormal returns after controlling for issuer type. However, there is a fundamental shift in the types of firms making private placements of common stock after the legislation-induced easing of resale restrictions. Specifically, we find that smaller firms and firms with greater information asymmetry are less likely to issue privately placed common stock after the legislative change, suggesting that the easing of resale restrictions reduces the We are grateful to an anonymous referee and the Managing Editor, John Doukas, for their valuable comments and suggestions. We thank Douglas Cumming, B. Espen Eckbo, Debarshi Nandy, Pauline Shum and Ed Waitzer for very useful feedback on earlier versions of this paper. Comments and suggestions from conference participants at the 501 costly signal that helps to overcome the Myers and Majluf (1984) underinvestment problem.

Are the Discounts in Seasoned Equity Offers Due to Inelastic Demand?

“…Bajaj et al (2001) and Robak (2007) present evidence that this restriction on re-sale accounts for much or all of the discount in US placements, though this has recently been challenged by Comment (2012). Maynes and Pandes (2010) find that discounts in Canadian placements became less deep after 2001, when the mandatory restricted period for re-sale was reduced in length. In the UK, there is no restriction on when the new shares can be sold, so this key explanation for discounts in placements does not apply in our sample.…”

“…However, some findings are suggestive. The discount is positively related to the relative size of the issue (Hertzel and Smith, 1993;Maynes and Pandes, 2010) and to the number of placees (Wruck and Wu, 2009;Huson et al, 2009). In addition, the argument that placements exist partly to enable the placee(s) to obtain costly private information about the issuer assumes that demand at the prevailing market price from less well-informed investors is insufficiently elastic.…”

Are the Discounts in UK Open Offers and Placings Due to Inelastic Demand?

“…The first is that the new shares in a private placement cannot be sold until registration has been declared effective by the SEC, except through a privately negotiated trade. Bajaj et al (2001) and Robak (2007) present evidence that this restriction on re-sale accounts for much or all of the discount in US placements, and Maynes and Pandes (2010) find that discounts in Canadian placements became less deep after 2001, when the mandatory restricted period for re-sale was reduced in length. In the UK there is no restriction on when the new shares can be sold, so this key explanation for discounts in placements does not apply in our sample.…”

“…However, some findings are suggestive. The discount is positively related to the relative size of the issue (Hertzel and Smith, 1993;Maynes and Pandes, 2010) and to the number of placees (Wruck and Wu, 2009;Huson et al, 2009). In addition, the argument that placements exist partly to enable the placee(s) to obtain costly private information about the issuer assumes that demand at the prevailing market price from less well-informed investors is insufficiently elastic.…”

The Calculation of Returns during Seasoned Equity Offers

“…Several event studies of private placements measure returns with no adjustment for the discount (Kang & Stulz, 1996;Allen & Phillips, 2000;Cronqvist & Nilsson, 2005;Wu & Wang, 2005;Barclay, Holderness & Sheehan, 2007;Maynes & Pandes, 2008;Wruck & Wu, 2009). Previous event studies of UK placings also make no adjustment for discounts (Slovin, Sushka & Lai, 2000;Barnes & Walker, 2006;Balachandran et al, 2009).…”