Why Include Warrants in New Equity Issues? A Theory of Unit Ipo's

Posted: 4 Jul 1995

See all articles by Thomas J. Chemmanur

Thomas J. Chemmanur

Boston College - Carroll School of Management

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School; European Corporate Governance Institute (ECGI)

Abstract

We develop a theory of unit IPOs, in which the firm going public issues a package of equity with warrants. We model an equity market characterized by asymmetric information, where insiders have private information about the riskiness as well as the expected value of their firm's future cash flows. We demonstrate that, in equilibrium, high risk firms issue "units" of equity and warrants, and the package of equity and warrants is underpriced; lower risk firms, on the other hand, issue underpriced equity alone. An important feature of our model is that, in contrast to the existing literature, underpricing is used as a signal in equilibrium in the context of a one-shot equity offering. While the model is developed in the context of IPOs of equity, it is also applicable with minor modifications to the case of seasoned equity offerings packaged with warrants; further, the intuition behind the model generalizes readily to provide a new rationale for packaging call option-like claims with other risky securities (e.g., convertible debt, debt with warrants) as well.

JEL Classification: D82

Suggested Citation

Chemmanur, Thomas J. and Fulghieri, Paolo, Why Include Warrants in New Equity Issues? A Theory of Unit Ipo's. Available at SSRN: https://ssrn.com/abstract=6436

Thomas J. Chemmanur (Contact Author)

Boston College - Carroll School of Management ( email )

Finance Department, 436 Fulton Hall
Carroll School of Management, Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)

HOME PAGE: http://https://www2.bc.edu/thomas-chemmanur/

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

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