Cheap-Stock Tunneling Around Preemptive Rights
39 Pages Posted: 11 Jun 2018 Last revised: 7 Nov 2018
Date Written: June 1, 2018
Preemptive rights are thought to protect minority shareholders from cheap-stock tunneling by a controlling shareholder. We show that preemptive rights, while making cheap-stock tunneling more difficult, cannot prevent it when asymmetric information about the value of the offered shares makes it impossible for the minority to know whether these shares are cheap or overpriced. Our analysis can help explain why sophisticated investors in unlisted firms and regulators of listed firms do not rely entirely on preemptive rights to address cheap-stock tunneling, supplementing them with other restrictions on equity issues.
Keywords: Controlling shareholder, tunneling, equity issuance, equity issue, equity tunneling, preemptive rights, minority shareholders, public shareholders, rights offers, rights issues, private firms
JEL Classification: G14, G18, G32, G34, G38, K22
Suggested Citation: Suggested Citation