Are PIPEs a Bet on Growth Options?

Abstract:     
Despite their "toxic" reputation Private Investments in Public Equity (PIPEs) remains an important source of financing providing in excess of $10 billion of capital to US firms per year over the five years to 2005. In this paper, we argue that there is more to PIPE funding than hedge funds profiting from corporate distress, exploring the possibility that the firm size, performance and information asymmetry contribute to the use of PIPE financing. We conjecture that the existence of information asymmetry induces the firm to undertake PIPEs and that the characteristics of the firm's investment opportunity set inïB02uences the level of information asymmetry. In particular, informational asymmetry is more severe the higher the uncertainties about future cash flows and the more profitable future growth options. We argue that firms choosing to issue PIPEs rather than SEOs are smaller research and development intensive firms with identified growth opportunities, but at an earlier stage of growth facing high information asymmetry. We find that the dominant PIPE structure is a plain-vanilla PIPE with positive returns during the 12 months prior to the issue. Both PIPE issuers and SEO issuers are investing heavily in future growth opportunities but with negative cash flow relying heavily on outside financing during the year prior to the equity issue. We find that traditional common stock PIPEs are more likely to be issued by smaller research and development intensive firms at an early stage of growth. The likelihood of undertaking a PIPE issue decreases with asset size and profitability, and increases the greater the proportion of firms assets represented by patents. Finally, we find that the return distribution of common stock PIPEs have large positive extreme values.

Number of Pages in PDF File: 32

Keywords: private placements, private equity, PIPE securities, R&D

JEL Classification: G23, G32

working papers series