What’s Wrong with Rights?

Abstract

We develop and test an explanation for the rights issue paradox that stems from risk of offering failure. Firms can reduce failure risk by getting underwriting or by self-insuring through subscription price discounts and subscription precommitments. Self-insurance is generally regarded to be relatively costless, but we provide evidence consistent with the existence of implicit costs. In particular, existence of self-insurance costs implies that firms with better projects will have larger discounts and that firms with higher ownership concentration will have more precommitments. Hence, our results support costly self-insurance against issue failure as a factor in explaining the rights issue paradox.

Keywords: Rights, Paradox, Failure, Seasoned equity offerings

JEL Classification: G14, G24, G32