Financing Under Extreme Risk: Contract Terms and Returns to Private Investments in Public Equity

Abstract:     
This paper examines financial contracting theories using the market for private investments in public equity (PIPEs). Variation in the risks of issuers and contract terms makes this market well suited to examine these theories. We document that the use of terms that are contingent on an issuer’s future performance increases with issuer risk. Among firms with poorer stock performance, higher cash burn rates, and more uncertain investment prospects, contracts that include only purchase discounts are uncommon and contingent contracting terms are used more extensively. Contingent terms that can shift control to investors are used by issuers in the poorest financial condition. The findings support theories that suggest contingent terms are used by investors to help manage contracting problems that can arise when funding firms with greater risks.

Keywords: private placements, financial distress, contracting costs, equity issuance

JEL Classifications: G24

Working Paper Series