Direct Equity Financing; A Resolution of a Paradox: A Comment

Posted: 1 Nov 2009

See all articles by Richard L. Smith

Richard L. Smith

University of California, Riverside - Anderson Graduate School of Management

Manjeet S. Dhatt

University of Minnesota - Duluth - Department of Finance and Management Information Sciences

Date Written: December 1, 1984

Abstract

In a recent article, Hansen and Pinkerton (HP) advance the "Comparative Cost Hypothesis" as a resolution to the equity financing paradox [1]. Their basic hypothesis is that the firm's choice between rights issue and general cash offer is resolved in a manner empirically consistent with issue cost minimization. To test this, they estimate a rights issue direct flotation cost function for a sample of 50 firms. The model is then used to infer the hypothetical rights issue cost for a different sample of 182 firms that employed underwritten public offerings. They find that the large majority of firms using public offerings would have incurred significantly higher cost via rights issue, a result consistent with the Comparative Cost Hypothesis. In this comment, we examine the sensitivity of the HP conclusion to the choice of empirical form of the rights issue cost function. We find that the empirical result is extremely sensitive to the functional form. In particular, using two reasonable alternative specifications, we find that the Comparative Cost Hypothesis of HP is not supported.

Keywords: direct equity financing, IPO

Suggested Citation

Smith, Richard L. and Dhatt, Manjeet S., Direct Equity Financing; A Resolution of a Paradox: A Comment (December 1, 1984). The Journal of Finance, Vol. 39, No. 5, pp. 1615-1618, December 1984. Available at SSRN: https://ssrn.com/abstract=1498022

Richard L. Smith (Contact Author)

University of California, Riverside - Anderson Graduate School of Management ( email )

Riverside, CA 92521
United States
951-827-3554 (Phone)

HOME PAGE: http://www.agsm.ucr.edu/

Manjeet S. Dhatt

University of Minnesota - Duluth - Department of Finance and Management Information Sciences ( email )

Duluth, MN 55812-2496
United States
218-726-7836 (Phone)

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