Adverse Selection and the Rights Offer Paradox
B. Espen Eckbo
Tuck School of Business at Dartmouth; European Corporate Governance Institute (ECGI)
Ronald W. Masulis
University of New South Wales - Australian School of Business; European Corporate Governance Institute (ECGI); Financial Research Network (FIRN)
Journal of Financial Economics (JFE), Vol. 32, No. 3, pp. 293-332, 1992
We develop an analytical framework to explain a firm's choice of equity flotation method and the near disappearance of rights offers by U.S. exchange-listed firms. The choice between uninsured rights, rights with standby underwriting, and firm-commitment underwriting depends on information asymmetries, shareholder characteristics, and direct flotation costs. Underwriter certification and current shareholder takeup of issues are viewed as substitute mechanisms for minimizing wealth transfers between shareholders and outside investors. Uninsured rights create adverse selction effects when shareholder takeup is low. Implications for stock price behavior around issue announcements, shareholder subscription precommitments, and relative issue frequencies are supported by large sample evidence.
Number of Pages in PDF File: 49
Keywords: Flotation method, seasoned common stock, SEO, stock offer, rights offer, adverse selection
JEL Classification: G24
Date posted: June 19, 2006
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