Private Investments In Public Equity Research Articles

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

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.

Shareholder litigation and short selling ahead of private equity placements

AbstractWe examine the impact of shareholder litigation on short selling ahead of private investments in public equity (PIPEs). We find that PIPE issuers that incurred securities class action lawsuits prior to the PIPE are shorted more heavily ahead of the PIPE issue. The case status at the PIPE date, the severity of the lawsuit, and the timing of the private placement after the litigation event also affect the extent of short selling activity ahead of PIPEs. Consistent with hedging incentives, the effects of prior shareholder litigation on short selling are more pronounced in PIPEs where lead investors are hedge funds and in traditional PIPEs.

Missing the boat: Regulatory approval delay and investment project outcomes

By using unique hand-collected project-level investment data on Chinese private investments in public equity (PIPE) issuances, we show that the length of the regulatory approval process for equity issuance is positively related to the probability of subsequent changes in equity-financed projects and a deterioration in project returns. The effects are more pronounced for firms in a highly competitive industry and with a comparative disadvantage. Furthermore, we show that this relationship is causal by exploiting the exogenous shock to approval delay caused by changes in the Chairman of the China Securities Regulation Commission. In response, equity issuers mitigate the delay impact by temporarily increasing debt financing.

How do Investors’ Capital Gains Tax Rates Affect Equity Offering Prices? Evidence from Private Investments in Public Equity

How do Investors’ Capital Gains Tax Rates Affect Equity Offering Prices? Evidence from Private Investments in Public Equity

Does innovation success reduce the cost of financing? Evidence from private investments in public equity

This paper investigates the relation between a firm's innovation performance and the cost of financing in private investments in public equity (PIPEs). Using patent-based metric data, I find that innovative firms issue securities in private equity placements at a 5.4% lower discount than non-innovative firms. The negative effect of innovation performance on PIPE discounts is more pronounced for firms in R&D intensive industries and firms with higher stock market illiquidity. Channel tests show that innovative firms are more likely to be led by strategic investors who are willing to pay a higher price to support innovative issuers. The results are robust to alternative methods that mitigate endogeneity issues.

The economics of PIPEs, revisited

This paper examines rent sharing in private investments in public equity (PIPEs) between newly public firms and private investors. The evidence suggests highly asymmetric rent sharing. Newly public firms earn a negative return of up to −15% in the first post-PIPE year, while investors benefit due to the ability to dictate transaction terms. The results are economically relevant because newly public firms are, at least in recent years, more likely to tap private rather than public markets for follow-on financing shortly after the initial public offering (IPO), and because the results for newly public firms contrast with those for the broad PIPE market in Lim et al. (2021). The study also contributes to the PIPE literature by offering an integrative view of competing theories of the cross-section of post-PIPE stock returns. We simultaneously test proxies for corporate governance, asymmetric information, bargaining power, and managerial entrenchment. While all explanations have univariate predictive power for the post-PIPE performance, only the proxies for corporate governance and asymmetric information are robust in ceteris-paribus tests.

Investor activism strategies of private equity firms: evidence from continental Europe

PurposeThis paper aims to deal with the issue of shareholder activism of private equity investors in public companies. The study identifies characteristics of target firms and investors related to the likelihood of private equity activism. The research also examines whether shareholder activism strategy of private equity investors is associated with the better performance in future and value creation of target firms.Design/methodology/approachThe paper applies econometric modeling to hand-collected data on private equity investments in listed companies, in the form of private investment in public equity and open-market share purchases, from eight Continental Europe’s countries for the period 2005–2014.FindingsThe findings indicate that the probability of shareholder activism is higher if the target firm’s industry corresponds to the private equity investor’s industry specialization, if the private equity firm is older, if the target is larger and the average ownership share purchased by the investor is higher. Conversely, the probability of shareholder activism is lower where a private equity firm invests in the target for the first time. A target firm with an activist investor has poorer operational performance results one year following the investment compared to a target firm with a passive private equity investor.Research limitations/implicationsResults from the analysis of transactions in Continental Europe countries with French and German legal origin may be not generalizable to other markets with the different legal tradition and institutional environment.Originality/valueThis research provides new empirical evidence on private equity activism in listed companies of Continental Europe. By distinguishing between active and passive investments, testing rarely considered characteristics to provide valuable insights and analyzing the effect of activism on the target firm’s performance, the study contributes variously to the still-limited body of literature on private equity activism in public companies with a governance structure based on concentrated ownership. The findings emphasize the relationship between shareholder activism and both target and investor’s characteristics from perspective of mitigating agency problem and value creation in target firms. By simultaneously investigating investments in public companies from several European markets, the study complements empirical evidence mostly obtained from studies of a single national market.

MILLSTEIN CENTER‐ECGI CONFERENCE ON: Board 3.0: Bringing the Private Equity Model to Public Companies

In a recent conference organized by Columbia Law School's Millstein Center and the European Corporate Governance Institute, law and econ scholars Jeff Gordon and Ron Gilson discuss with other academics and a remarkably varied and distinguished group of practitioners the possibility of “porting” elements of the private equity governance model to public companies to achieve what they describe as “Board 3.0.” The public company “monitoring” boards of the recent past—composed for the most part of part‐time, “thinly informed,” and “boundedly motivated” directors dependent upon corporate management for information about the company—are seen as evolving toward the “thickly informed, well‐resourced, and powerfully motivated” directors that Gordon and Gilson see as required to function more like “partners” in the business, helping steer management toward the long‐run value‐maximizing strategic and operating decisions.A number of the board members on the panel serve, or have served, on private as well as public companies. The consensus among this group was that PE boards function at higher levels than their public counterparts, accounting in significant part for the higher returns of PE. But as this group also noted, an ongoing “migration” of PE board members and practices to public companies, accomplished in part by reverse LBOs and PIPEs (private investments in public equity), is leading to more effective public company oversight and governance. Along with deeper specialized knowledge of critically important operational issues, PE directors are also said to have a comparative advantage in designing pay‐for‐performance incentives for operating managers. What's more, as one panelist pointed out, PE's need to focus on and prepare for “exit” from day one has the paradoxical effect of sharpening managerial attention on the long‐term future and the amount and kinds of investment needed to ensure it.

Board independence and PIPE offerings

Using hand-collected governance data and a two-stage least squares approach to control for the endogeneity of firm governance structure, this paper shows that private investments in public equity (PIPE) issuers with higher board independence grant investors lower price discounts and experience improved announcement effects, improved long-run operating and stock performance, and increased investment. Board independence also encourages issuers to place more shares with venture capital investors, and fewer shares with managerial investors. These findings suggest that strong independent governance can mitigate the agency costs inherent in PIPEs.

A global analysis of Private Investments in Public Equity

Raising equity capital via Private Investments in Public Equity (PIPEs) has been rising in popularity, matching Seasoned Equity Offerings (SEOs). We use over 10,000 PIPEs in a global setting during 1995–2015 to assess how and through which channels institutional frameworks affect the issuers' performance. We document a significant decline in the market reaction, especially during 2004–2015 and find that firms issuing equity via PIPEs have significantly worse fundamentals. We also show that country governance matters as issuing firms operating in countries with better regulatory environments outperform others. Finally, we find that regulatory enforcement is a plausible underlying channel for the positive effect of the institutional frameworks on PIPEs performance.

Litigation and Information Effects on Private Sales of Securities

We analyze the resolution of information asymmetry in transactions of private investments in public equity (PIPEs) in which the issuer has experienced class action lawsuits. We explain the associated wealth and pricing effects (information effects). We show that litigated PIPEs are associated with higher announcement wealth effects and lower levels of discounts than non-litigated PIPEs. We find that disclosure, prior investors’ ownership, early registration, and intermediation have positive information effects on incumbent and new investors when issuers concurrently pursue the desired corporate actions (proxied by the auditor changes). We conclude that PIPE issuers can mitigate information effects from prior litigation.

How Costly is Follow-on Financing After Premature Going-public Decisions?

Entrepreneurs often regard Initial Public Offerings (IPOs) as the crowning pinnacle at the end of a highly successful entrepreneurial journey, and studies in entrepreneurial finance therefore rarely extend beyond the going-public decision. This research gap is important because many post-IPO entrepreneurs need to revert to their pre-IPO entrepreneurial investors for follow-on financing in private transactions as they fail to raise additional equity in public markets. While the investment relationship is usually mutually beneficial pre-IPO, the rent sharing in post-IPO transactions is less obvious. Evidence from Private Investments in Public Equity (PIPEs) over the 2001-2018 period in recent-IPO firms suggests highly asymmetric rent sharing. Entrepreneurs earn a negative return of up to -15% in the first post-PIPE year, while investors benefit due to the ability to dictate transaction terms. We find some evidence that corporate governance and asymmetric information considerations matter in the cross section of the returns. The results have real implications for entrepreneurs who often remain CEO of the public company and have a large portion of their personal wealth tied to their company stock.

How reverse merger firms raise capital in PIPEs: search costs and placement agent reputation

We examine the role of placement agents in private investments in public equity (PIPE) deals of firms that went public via a reverse merger (RM). We find that reputable placement agents with greater expertise (expert agents) help RM firms to complete their PIPE deals in a smaller number of financing rounds (closings) and raise funds from a larger base of private investors. In exchange for these benefits, RM firms advised by expert agents agree to more investor-friendly contract terms and pay higher cash compensation to their placement agents. Overall, our evidence indicates that, while expert PIPE agents use their superior networking capabilities to reduce the search costs of RM firms, they also exercise more bargaining power against RM firms compared to non-expert PIPE agents. Finally, compared to the PIPE offerings of IPO firms, the PIPE offerings of RM firms are more likely to involve deals with multiple closings and larger offer price discounts. This suggests that raising new capital in PIPEs entails significantly higher costs for RM firms than IPO firms.

The economics of PIPEs

Private investments in public equities (PIPEs) are an important source of finance for public corporations. PIPE investor returns decline with holding periods, while time to exit depends on the issue's registration status and underlying liquidity. We estimate PIPE investor returns adjusting for these factors. Our analysis, which is the first to estimate returns to investors rather than issuers, indicates that the average PIPE investor holds the stock for 384 days and earns an abnormal return of 19.7%. More constrained firms tend to issue PIPEs to hedge funds and private equity funds in offerings that have higher expected returns and higher volatility. PIPE investors’ abnormal returns appear to reflect compensation for providing capital to financially constrained firms.

The certification role of insider participation in PIPEs

In this paper we provide new insights into the motives underlying insider participation in private investments in public equity (PIPEs) by considering the association among insider participation, pricing, and contractual terms. PIPEs are a financing choice that have become popular over the last decade and frequently involve insider participation. We find that board seats and weak pre-PIPE performance are important determinants of insider participation. We also find evidence in support of the certification motive for insider participation. In particular, we show that insider participation is associated with lower PIPE discounts and improved future firm operating performance. Announcement wealth effects are significantly higher when insiders participate than when they are absent both for single and repeated PIPE transactions. We extend the prior literature by documenting that the insider certification effect also exists for repeated PIPE transactions and that the granting of control mechanisms, such as board seats, is an important component of contractual arrangements in insider participation, potentially to achieve incentive alignment by mitigating moral hazard considerations.

How Reverse Merger Firms Raise Capital in PIPEs: Search Costs and Placement Agent Reputation

We examine the role of placement agents in private investments in public equity (PIPE) deals of firms that went public via a reverse merger (RM). We find that reputable placement agents with greater expertise (expert agents) help RM firms to complete their PIPE deals in a smaller number of financing rounds (closings) and raise funds from a larger base of private investors. In exchange for these benefits, RM firms advised by expert agents agree to more investor-friendly contract terms and pay higher cash compensation to their placement agents. Overall, our evidence indicates that, while expert PIPE agents use their superior networking capabilities to reduce the search costs of RM firms, they also exercise more bargaining power against RM firms compared to non-expert PIPE agents. Finally, compared to the PIPE offerings of IPO firms, the PIPE offerings of RM firms are more likely to involve deals with multiple closings and larger offer price discounts. This suggests that raising new capital in PIPEs entails significantly higher costs for RM firms than IPO firms.

Private Information Index and Proprietary Costs

We develop a firm-level private information index with three unique features. First, the index is a direct measure of the nature and magnitude of private information that is proprietary. Second, it is multi-dimensional. Third, it is not specific to any one setting. We conduct several tests to validate this index against extant firm-specific and industry-level proprietary cost proxies. We then use it to examine the role of proprietary information in a firm’s equity financing choice between private investments in public equity (PIPEs) and seasoned equity offerings (SEOs). In this context, the proprietary cost hypothesis posits that firms wanting to avoid public dissemination of sensitive private information can do so more effectively by choosing PIPEs over SEOs. Our tests provide strong support for the hypothesis. The results are robust to alternate index specifications and other factors that influence this choice.

Price inversion and post lock-up period returns on private investments in public equity in China: An interest transfer perspective

This paper documents an anomaly in privately-placed stock returns in China and provides an explanation based on deliberate interest transfers. Using a sample of private investments in public equity (PIPEs) with lock-up periods ending between 2007 and 2015, we find that stocks with price inversion (unlock-date price lower than the issuing price) generate higher short-term returns post lock-up period than other stocks, and the greater the degree of price inversion, the better the short-term returns. This anomaly cannot be explained by the effects of price reversal, investors' under-reaction to companies' prospects, or improved governance after PIPEs. Rather, it reflects the interests transferred by issuing firms to participating investors via means including aggressive earnings management and dividend increase, given the unique regulations on PIPEs in China. Interest transfer is particularly pronounced if local investors participate in a PIPE, but sound corporate governance can restrain it.

A Global Analysis of Private Investments in Public Equity

Raising equity capital via Private Investments in Public Equity (PIPEs) has been rising in popularity, matching Seasoned Equity Offerings (SEOs). We use over 10,000 PIPEs in a global setting during 1995-2015 to assess how and through which channels institutional frameworks affect the issuers’ performance. We document a significant decline in the market reaction, especially during 2004-2015 and find that firms issuing equity via PIPEs have significantly worse fundamentals. We also show that country governance matters as issuing firms operating in countries with better regulatory environments outperform others. Finally, we find that regulatory enforcement is a plausible underlying channel for the positive effect of the institutional frameworks on PIPEs performance.

The choice between PIPE and SEO in China

China's private investment in public equity (PIPE) market has exceeded the aggregate proceeds raised by its seasoned equity offering (SEO) market. Taking into account the institutional and regulatory backgrounds of China's secondary equity markets, this paper examines how listed firms choose between PIPE and SEO. Firms with both options tend to be induced by the greater flexibility in its equity offering mechanism to choose PIPE over SEO, particularly when stock price volatility is high or the market is performing poorly. SEO issuers are more likely to time the stock market. Post issuance abnormal returns, in both short- and long-run tend to be higher for PIPE than for SEO issuers.