The role of financial covenants in pricing private investments in public equity

Abstract

Our study examines the pricing of private placements for issuing firms subject to outstanding loan covenants. Using Private Investments in Public Equity (PIPE) deals from 2001 to 2018, we find that issuing firms restricted by loan covenants offer a discount of 3.9% larger than those without covenants. We corroborate the positive impact of financial covenants on discounts through channel tests that assess covenant violation history, covenant strictness, and the identities of lead PIPE investors. The increased probability of technical default and costly renegotiation in covenants potentially incentivizes borrowing firms to transition from the loan market to the PIPE market. To minimize endogeneity concerns, we use a matched sample, a Heckman selection model, and a two-stage least squares instrumental variable analysis, all of which present consistent results. Based on our findings, we conjecture that PIPE investors are concerned about the transfer of control rights to lenders and, as a result, demand deeper discounts in PIPE offerings.